The Canadian Revenue Agency (CRA) is cracking down on unreported income from pre-construction condo flips in hot markets such as Toronto and Vancouver, according to the agency. And it is causing some serious headaches for local investors looking to sell their units before taking possession.
Although the CRA has not changed any policy, it has “increased its efforts in the real estate sector for identified pockets of tax non-compliance risk,” the agency said in a statement.
Tax lawyer Neil Bass told Post City that the CRA has become “more aggressive” in its audits and collection efforts in recent years.
“What has changed are the audit and enforcement methods the CRA is using to ensure sellers are properly reporting and paying the taxes [owing] as a result of flips,” Bass said.
He explained that enhanced auditing by the CRA began a few years ago when flipping condos became profitable due to “rapidly escalating property values.”
According to the CRA, the agency doubled its level of effort to uncover tax issues in the British Columbia real estate sector in 2015 and reviewed 500 “high dollar” real estate transactions in the province.
The agency also has used “greater scrutiny” on transactions in the GTA for “some years,” according to its website.
Bass runs down a common scenario whereby someone purchases a condo in which to live, something happens in the real world before the condo closes or is occupied, and the pre-construction owner subsequently arranges to assign the purchase agreement.
Assignment is the process whereby someone sells a pre-construction condo prior to taking occupancy or ownership of the unit.
According to Bass, the tax consequence that should apply is that the gain from the assignment should be treated on account of capital such that 50 per cent would be included in the income of the person selling and the amount received on the assignment would be subject to HST.
“But, the CRA will likely assert that the condo was purchased for the purpose of resale and, in addition to the HST on the amount received in consideration of assigning the condo, the proceeds will be considered to be on income account such that 100 per cent of the gain (not capital gains) would be included in income,” he said. “The person will then have to satisfy that his or her intention was to live in the condo.”
If they don’t, this could come back to haunt them, especially with renewed attention from the CRA.
From April 2015 to December 2018, the agency completed over 38,000 files looking into income tax, GST/HST and GST/HST New Housing and New Residential Rental Property Rebates in Ontario and British Columbia, amounting to over $850 million in audit assessments, according to its website.
Real estate and finance professor Tsur Somerville said that there has been a sense that people are not declaring income on pre-construction condo sales or what are called condo assignment sales.
Somerville explained that flipping a condo before it is move-in ready can be profitable given that it can be sold at a higher price if the condo becomes worth more in later years, but one only has to put down a deposit, say 20 per cent, on it and not pay the condo cost in full.
“You’re essentially able to get the capital gains in real estate without ever actually having to acquire the real estate, without having to pay the entire purchase price,” Somerville said.
Bass said that the CRA is doing targeted audits of pre-construction condo flips because the “flipper’s” name does not appear in land registry systems.
“Many of the flips were under the radar and not reported in the assignor’s tax returns or improperly reported,” Bass said.
He says that typically the only people who know that the condo was flipped are the developer, the person selling and the buyer.
In addition to Canadian residents flying under the radar in pre-construction flips, the process can also include non-residents, according to Bass.
“In particular, a concern to the CRA was that many condominium projects were sold in large part to foreign investors,” Bass said.
“When these investors assigned their contracts, the money went out of Canada and those investors did not report their gain.”
Bass said, if someone purchases property from a non-resident, there is an obligation on the purchaser to withhold and send an amount to the CRA towards the non-resident’s tax liability, which many purchasers were not aware of.
He said a requirement to charge GST/HST on the sale was “largely being ignored.”
“Collectively, this represented a large loss of tax revenue to the Canadian government,” Bass said.
“Properties bought for resale are taxed as regular income and 100 per cent of the profits are taxable.”
However, things can get complicated quickly, Bass pointed out, considering that the starting point of all audits on condo assignments is based on the intention to resell.
“That has proven problematic for those who bought for investment purposes or as a home to live in but circumstances changed to necessitate a sale,” he said. “Intention and actual use become critical factors.”
According to the CRA, in most cases, capital gains, the profits made from a sale, are taxable and must be reported, but sellers can avoid paying tax on some or all of the capital gains through the principal residence exemption, which can be applied if the property was the seller’s main residence.
Ultimately, Bass said there is no change in what taxes the person has to report and pay or the taxes that apply, only in the efforts of the CRA to gather information.
“People are caught off guard by the CRA’s ability to gather information that many improperly assumed was under the radar,” he said. This ability includes the CRA going to court to get “judicial authorization” for a number of condo developers to supply a list of all pre-closing assignments.
The consequences of not reporting or not properly reporting taxes include reassessments for the taxes plus interest, possibly penalties and if the non-reporting is deliberate, it may be tax fraud or evasion, which can lead to criminal charges, Bass said.
The CRA states on its website it will apply a penalty equal to 50 per cent of the additional tax payable if a false statement is knowingly made when filing a return.
“The best thing people can do is properly document and retain documentation, not only the transactions themselves, but also for supporting the intended purpose of the purchase,” Bass said.