Author: Edward Tse

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The new anti-flipping measure took effect in January 2023 and is another effort by the government to control real estate speculation in Canada, similar to the foreign buyer ban. If real estate is bought and sold within 365 days, the CRA deems the property to be “flipped property” and any profit from the transaction is treated as business income to the taxpayer. There are specific exemptions outlined below.

Background

The anti-flipping measure was put into place by Bill C-32 and amends the Income Tax Act (the “ITA“) to add a subsection specifically to deem proceeds from a “flipped property” as business income meaning 100% of the profit is included as income for the taxpayer. In the past, one of the advantages of transacting in real estate was that the profit could be treated as a capital gain and therefore only 50% of the profit would be taxed in the hands of the taxpayer.

Even before this anti-flipping measure, if a taxpayer flipped property, it would still generally be classified as business income. But taxpayers who did this in their personal capacity often reported any profits as a capital gain by justifying the real estate as an investment property and/or making use of the Principal Residence Exemption (more on that below). The new anti-flipping measure introduces a “bright-line rule” to prevent taxpayers from taking advantage of this grey area.

What is “Flipped Property”?

It is important to distinguish between the colloquial term we use everyday when we talk about “flipping property” and the CRA definition.

Colloquially, a simple definition of flipping property is the act of buying and selling a property quickly for profit.

In the anti-flipping measure, the CRA’s definition of “flipped property”: is any housing unit of a taxpayer that was owned for less than 365 consecutive days prior to the disposition of the property with several important exemptions. If the disposition occurred due to, or in anticipation of one or more of the following events, then it would not be considered flipped property:

• death of a taxpayer or a person related to the taxpayer;
• change in the taxpayer’s household in connection with a related person;
• breakdown of a marriage or common-law partnership if the partners have been living separate and part for at least 90 days prior to disposition;
• a threat to the personal safety of the taxpayer or a related person;
• the taxpayer or a related person suffering from a serious illness or disability;
• an eligible relocation (as defined in s248(1) of the ITA);
• an involuntary termination of employment of the taxpayer or the taxpayer’s spouse or common-law partner;
• the insolvency of the taxpayer; or
• the destruction or expropriation of the property.

The CRA’s definition of “flipped property” tries to capture the colloquial definition while introducing a level of certainty by creating a strict cut off point (a “bright line”) of 365 days of ownership. While the cut off is somewhat arbitrary, it eliminates a lot of the grey area as the previous requirement was based on intent of the taxpayer.

The CRA also disallows any loss from a flipped property if it falls under this S12 deeming provision for flipped property. Note that if the property is inventory of the taxpayer (ie. in a business that purposely buys and flips property) the loss would not be denied. This new deeming provision is not meant to capture and “punish” a dedicated real estate flipping business as they already treat any profit as business income.

What about the Principal Residence Exemption?

The Principal Residence Exemption will not exempt the gain from a flipped property. Unless the taxpayer is selling due to one of the exemptions, even if the property they sell is their personal residence, the gain will not meet the Principal Residence Exemption because the proceeds are deemed business income due to this new anti-flipping measure. See paragraph 2.6 of Income Tax Folio S1-F3-C2 for a detailed explanation why.

Potential GST/HST Implications

The Excise Tax Act (the “ETA“) imposes an obligation to remit GST/HST on taxpayers who are considered a “builder” under the Act. A taxpayer can be considered a “builder” if they resell a newly constructed property (ie. buying and selling a pre-construction condo soon after closing) or sell a property in which they substantially renovated.

For taxpayers who have deemed flipped property business income and meet the builder definition of the ETA, they will be required to remit to the CRA GST/HST. This means that the transaction price of the property will be deemed to include GST/HST that the seller will need to remit to the CRA which will further erode the profit, if any, from a flipping transaction.

Tips

If a taxpayer is in the situation of selling within the 365 day ownership period due to one of the exemptions, they should retain documentation for proof. The taxpayer has the burden to prove to the CRA that an exemption applies if the taxpayer is audited. Furthermore, the taxpayer should consult with a tax professional to ensure that their situation and/or documentation is sufficient to meet the exemption. By consulting a professional and relying on their expertise, it also offers taxpayer a layer of protection as the taxpayer has done their due diligence.

The CRA implements several algorithmic tools to flag returns for audits. If a taxpayer has a history of claiming the Principal Residence Exemption frequently, it might flag their return for a questionnaire and potentially an audit. Note that the CRA can reassess a taxpayer’s T1 return up to three years after the original Notice of Assessment but if the CRA alleges fraud or misrepresentation, they can reassess further back. In these audits and reassessments the burden of proof is always on the taxpayer therefore it is vitally important to consult a tax professional as early as possible in the process. Whatever the taxpayer tells the CRA should be able to be corroborated or proven through documentation or third parties.

Taxpayers should keep in mind that even if a property is sold after the 365 holding period, the transaction might still be considered business income from a flip. The determination will be based on the facts of the situation.

The anti-flipping measure is coming at a difficult time for taxpayers. With the increase in interest rates and mortgage payments, some home owners may find themselves in a difficult position financially. If the home owner has owned the property for less than 365 days, they might be caught under this anti-flipping measure even if they do not think they are flipping property.

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The 2022 Federal budget included a few changes to the way some real estate transactions are taxed. The two mains changes are the new residential property flipping rule and changes to the way GST/HST on assignments is taxed for individual. In this post I will be discussing the latter.

Summary of the changes to GST/HST on assignments effective May 7th 2022:

1. The new change makes it so that there is GST/HST on assignments regardless of original intentions. Previously, if the original intention of entering the pre-construction contract/Agreement of Purchase and Sale (APS) was for personal use, GST/HST on assignments did not apply. But if the intention was to sell for profit or flip the property, GST/HST applied.
2. The legislation officially recognizes that GST/HST is not payable on the portion of the consideration exchanged that represents the deposit that the assignor paid to the seller/builder.

I have seen people talk about these changes as if it will slow down the housing market because they seem to incorrectly assume that GST/HST on assignments is double levied or increased. The changes actually add certainty to the way GST/HST on assignments are taxed.

Let’s do an example of pre- and post- May 7th 2022 changes. Here is the assignment details (closely maps on to OREA Form 145/150 Schedule B):

• Purchase Price on the original APS = $1,000,000
• Payment by Assignee to Assignor for this Assignment Agreement = $100,000*
• Total Purchase Price including the Original APS and this Assignment Agreement: $1,100,000
• Deposit paid by the Assignor to the seller under the original APS to be paid by the Assignee to the Assignor: $200,000

**For the sake of simplicity, this excludes GST/HST but in practice, most assignment agreements will stipulate that GST/HST is included

Under the pre-May 7th 2022 rules according to the CRA*, GST/HST would have been payable on the whole amount that the assignee pays to the assignor, $300,000, which results in HST payable of $39,000 in Ontario (13%*300,000).

*Note that it was the CRA’s view that GST/HST is levied on the deposit. In reality this was challenged successfully in a 2013 Tax Court case and a taxpayer can file their GST/HST return without including the amount attributable to the deposit. But the CRA continued to levy GST/HST on the deposit amount in audits and reassessments so taxpayers unaware of the Tax Court ruling would end up paying additional GST/HST.

Under the post-May 7th 2022 rules, GST/HST on assignments is officially only payable on the payment by the assignee to the assignor, $100,000, which results in HST payable of $13,000 in Ontario. This will force the CRA to update their practice guidelines and hopefully they will no longer expect GST/HST on deposits in audits and reassessments.

The Nitty-Gritty

Lately, I have seen a lot of incorrect information shared by investors, agents, accountants, and lawyers regarding the new GST/HST changes so I hope that this post can put to rest any uncertainty on this issue by giving concrete examples and referring to the budget documents (the link goes to the Supplementary Information attached to the Federal Budget).

Many people are confused about the new changes to GST/HST on assignments and I think it largely stems from the imprecise use of language when talking about assignment agreements.

Before we begin, let’s start with some general definitions I will use in this post and are relevant in assignments:

• APS = Agreement of Purchase of Sale = Pre-Construction Contract
• Buyer = Assignor. The buyer is the individual who signed APS to buy the property. They will also be the assignor in the assignment agreement by assigning the APS to the assignee.
• Seller = Builder. The seller is the builder who signed the APS to sell the property. Note that most pre-construction agreements have a clause that give the seller some rights in an assignment of the contract (ie. seek seller permission and/or an assignment fee).
• Assignee = first occupant. The assignee is the person who will be assigned the APS and wants to eventually close on the property and live in it therefore, in most cases, they will be the first occupant.
• Taxable Supply – means a supply that is made in the course of a commercial activity (from the Excise Tax Act (the “ETA“) S123(1))
• Budget Day – April 7th 2022.

There are two main paragraphs most relevant to the new changes and I will explain what both of them mean. The first:

I believe some people have misinterpreted this paragraph, specifically the underlined section. The total amount paid by the first occupant is the purchase price on the APS (net of GST/HST as it is usually included in the price) plus the amount the first occupant/assignee paid for the assignment contract (also net of GST/HST).

The legislators have reframed the GST/HST on assignment sales from a taxable supply provided by the assignor, to the GST/HST owed because that is the “true purchase price” that the first occupant paid for the property. There is no double taxation. The amount of GST/HST on assignments is just being levied on the original APS price plus the additional amount the assignee paid to the assignor.

Which leads to the next paragraph:

The GST/HST on the deposit never made sense because the assignee was essentially returning the deposit that the assignor already paid to the builder which was already subject to GST/HST in the APS. This new reframing of the assignment sale solves that quirk because the deposit is already accounted for in the assignee’s “true purchase price”.

The Nittier-Grittier

So this is where going to law school comes in handy. If the above has not convinced you, please read on but otherwise, this might be a bit dense as I convert each part of the change to the ETA in everyday language that even a non-tax lawyer can understand (hopefully).

Translation/simplification: If a taxable supply by way of an APS is entered into …

Translation/simplification: …and if there is another supply (profit from the assignment) by way of the assignment of the APS, then the following rules apply:

They key phrase here is “other supply” because it does not refer to the original taxable supply which would have been the entire purchase price of the property in the APS. Instead, the “other supply” refers to the profit the assignor made in assigning the APS to the assignee.

Translation/simplification: (a) the profit from the assignment agreement is deemed to be a taxable supply.

Translation/simplification: (b) the profit from the assignment agreement is determined by the following formula A-B where

Translation/simplification: A is the total amount the assignor received before HST, and

Translation/simplification: B is a reimbursement from the assignee to the assignor for the deposit paid in the APS if applicable

And putting it all together:

If a taxable supply by way of an APS is entered into and if there is another supply (profit from the assignment) by way of the assignment of the APS, then the following rules apply

(a) the profit from the assignment agreement is deemed to be a taxable supply.

(b) the profit from the assignment agreement is determined by the following formula A-B where

• A is the total amount the assignor received before HST, and
• B is a reimbursement from the assignee to the assignor for the deposit paid in the preconstruction agreement if applicable

Conclusion

This new change introduces more certainty and logic into the tax code which is good for society overall.

Realistically, this only disadvantages those who have a change in circumstance and are “forced” to assign their property before closing. For example, this could be due to interest rate hikes that prevent a taxpayer from obtaining a mortgage or getting a new job elsewhere and no longer needing the property.

But it does create a positive incentive for real estate flippers to follow the law as it closes off one of the avenues for avoiding GST/HST on assignments (though income tax is a whole other issue). I don’t think it will have any meaningful effect on house prices, unless people believe in the incorrect information.