Real estate agents have always been subject to a disproportionate number of audits by the Canada Revenue Agency (CRA). In 2013, the CRA Audit Divisions began reviewing virtually EVERY sale of a residential home back to 2011 and earlier to reassess for extra taxes payable. With house prices in the GTA region rising by about 7% a year since 1997 including 8.4% in 2014 alone, the CRA is being opportunistic and engaging in abusive audits of home sales. This is a pure ’tax grab’ on their part.. NOTE: The CRA now has new state-of-the-art computers and programs to target the real estate market including tracking activity on the MLS Service and checking titles using the Teranet Service.
There are only 4 types of treatment on the sale of residential homes. The Principal Residence Exemption (PRE) exempts the FULL gain from taxation if the home is used primarily for personal usage during the entire period of ownership. If you rent out the basement – – 34% of floor-space – – and claim a 10% home/office expense for business, the entire gain is still exempt so long as the primary purpose – – 51% or more – – was personal usage. Business usage of less than 50% of the floor-space amounts to only ’incidental business usage’ to the primary purpose of personal usage.
The PRE is a ‘year-by-year designation’ for each year or part-year of personal usage PLUS 1 ‘bonus year’. If you live in a home for 7 years and rent it out for 5 years then the property is treated as a “mixed-usage property”. You can designate it for each full or part year of personal usage. So, if you designate 7 years of the 12 years of ownership, your partial exemption will be calculated as:
7 + 1 over 12 or 8/12ths (2/3) of the calculated net gain on sale.
The third tax treatment is treating the sale as a capital disposition in which case only ONE-HALF of the net gain is taxable. This 50% exemption applies to gains on stocks, mutual funds, rental properties and such as cottages or a Florida condo on which you do not claim the PRE. Always save the PRE for your home with the largest increase in value.
The last type of treatment is FULL taxation of a gain as ‘regular income’ which occurs (a) if you sell/assign an offer before getting title or (b) relist for sale on MLS too soon after getting title – – familiarly known as ‘flipping’ a property or (c) where investors in rental proper- ties re-sell the property within the first 12 to 15 months of ownership.
20.05% FEDERAL/ON RATE ON TAXABLE INCOME
From $ 0 to $45,916;
31.5% FEDERAL/ON RATE ON TAXABLE INCOME
From $ 45,917 to $91,831;
46.19% FEDERAL/ON RATE ON TAXABLE INCOME
From $91,832 to $142,353;
47.97% FEDERAL/ON RATE ON TAXABLE INCOME
From $142,354 to 220,000
53.53% FEDERAL/ON RATE ON TAXABLE INCOME
Developers must provide the CRA with a digitalized list of all individuals who sign an agreement of purchase and sale on new condos, townhouses and homes.
If a taxpayer sells – – ‘flips’ – – the offer, the CRA will identify the sale
by comparing the name(s) on the deed to the name(s) on the offer.
Where the name(s) are different, the CRA has found a ‘flip’. Gotcha!!
If you ‘flip’ an offer and fail to declare the FULL gain in your tax return, you should file a “Voluntary Disclosure Application”.
The application must be: (a) “voluntary” meaning the CRA has not commenced action; (b) provide full disclosure; (c) involve a penalty, and (d) the information must 1 year overdue. The CRA is happy to waive the 50% penalties. If you sell more than 1 offer without declaring the income, you might be prosecuted in the criminal courts under s. 239 (1) of the Income Tax Act (ITA) and face up to 200% penalties and 2 years in jail.
A shocking 2015 development is that the CRA is demanding that those who assign/sell offers obtain a Business Number and charge and remit 13% HST on the sale proceeds.
The New Home Buyer’s Rebate (NHBR) applies to homes bought for personal usage. The rebate is $24,000 of HST for all homes purchased for $400,000 and higher. The corresponding Tenant Home Buyer’s Rebate (THBR) applies to rental properties, which by way of a lease, you can prove 1 year of tenancy and is equal to the rebate for personal-use properties. You will be forced to repay the NHBR if you fail to take personal occupancy, and with the THBR you will be forced to repay the tenant rebate if you re-sell the home within a few months of getting title.
A recent development for those deemed to be “trading” in real estate such as ‘flipping’ an offer and a ‘quick sale’ of either a personal home or a rental property is to re-characterize the net gain as “business income” and levy 13% HST on the amount of the gain under the Excise Tax Act. This practice will not stand up to court challenge. It verges on being ridiculous.
The CRA is denying tax-free PRE status to taxpayers who get title of pre-construction condos which have gone up 30% to 35% or more and re-sell the new condo within 8 to 9 months of getting title. The CRA is taxing the full gain as “business income” plus levying 50% penalties under Section 163 (2) of the ITA plus interest. Disgraceful! Three points here.
‘Flips’ of offers and rental properties will always be taxed on the full gain on sale. Investors in rental properties should hold the property for at least 18 months to ensure that they get capital gains treatment with
½ of the gain exempt. The CRA will look at “the number and frequency” of transactions and the “length of the holding period” and will tax the full income by concluding that you are engaging in “an adventure in the nature of trade” – – business activity.
The CRA is citing s. 152(4) of the ITA to get around the 3-year limitation to reassess a tax return by stating that a taxpayer has made a “misrepresentation” or shown “carelessness” in a statute-barred tax return. Auditors use the most trifling of errors including the failure to claim PRE status on the sale of their home in a tax year as cause to reassess. “Misrepresentation” can be “negligent” or “innocent” in nature with the last involving mere inadvertence to be recognized by the courts as sufficient grounds to re-assess. The failure to claim PRE status in a personal tax return might open that tax year to audit
This is a painful area of tax law. Real estate agents are an easy target for CRA personal tax auditors since they are the last profession which is not allowed to incorporate and the rules for deducting expenses are very restrictive.
CRA auditors are trained by management to be militant and unreasonably harsh on audits and to reassess for the maximum amount of taxes payable. Clearly deductible expenses such as the high costs of such as they Brian Buffini special seminar courses, which can cost up to $15,000 to $18,000 or more, will be disallowed with the auditor citing s. 67 of the Income Tax Act to conclude that they are “unreasonable in scale”. Our firm argues that these courses are customized for the real estate industry and comply with trade and industry practic- es in real estate and we have NEVER lost this deduction. You have to stand up to auditors.
The agent will be asked to produce an auto logbook – – which is not required under the ITA or its related Regulations – – knowing that 99% of agents do not keep a logbook. You will get no more than 75% business driving without a logbook and will face a reduction to 60% or less. [ If you get the Odotrack computerized logbook service, your business usage of the car will be unchallengeable.]
The agent’s home has been their “primary place of business” – – Section 18 (12) (a)(i) of the ITA – – since they were required to pay for the MLS service and installed it in their home. This change made the whole industry ‘home-based’. Our firm has NEVER lost the home/of- fice expense on audit. Get professional representation to minimize the damage.
The Tax Fairness for Realtors Act (TFRA) passed SECOND reading of three required readings in the spring of 2017.
The Act requires that the agent own ALL of the “equity shares” – – voting shares – – of the corpo- ration and reads that non-equity – – non-voting – – shares can be issued to “… the members of the immediate family of that person…”. This confers the huge benefit of being able to favourably split both salary and dividends with family members.
There are benefits to incorporating as well as bookkeeping and audit problems which might arise. You get lower taxation by getting the commission income of the corporation into the hands of shareholders while paying the least taxes possible – – also referred to as ‘tax optimization’. Get a corporate credit card and pay all expenses from the corporation but NEVER commingle personal expenses in with business expenses.
The Small Business Deduction (SBD) allows active Small Corpora- tions (CCPCs) offering a service and/or product to the public a low combined Federal/Provincial tax rate of 15.5% on their first $500,000 of taxable income. Over $500,000, the combined rate is 26.5%. Corporate interest, dividends, net rent and capital gains – – “passive income”- – is taxed at a punitive rate of 46.17%. CAUTION: NEVER buy rental properties in the name of a company as rents and capital gains are taxed at the punitive rate. ‘Bonus’ yourself DOWN to the
$500,000 threshold. “Bonuses” are immediately deductible but payable up to 6 months later in the next personal tax year. Dividends may also pay paid in the next personal tax year. You can cut short your self-employed tax year by timing the conversion to corporate status. All of these are tax deferrals.
You and your spouse, if applicable, MUST be employees of the corporation – – see the Wiebe Doors case. You cannot bill your corporation for services as an independent contractor. You can select the blend of salary and dividends which is most favourable in tax terms. Salary payments are subject to tax and Canada Plan premiums withholding. The employee and the corporation must make matching CPP contributions up to the 2015 limit of $53,600. Do not withhold CPP premiums beyond the limit as the excess amounts will be repaid to the employee but the corporation will get only a deduction on the excess amounts saving at ONLY the 15.5% tax rate.
Each employee of a corporation can set up an Individual Pension Plan (IPP). These plans are separate from RRSP plans but the contribution room is about 50% more generous than with RRSP plans and there is no taxable benefit levied. The higher earners and full-blown brokers should have an IPP. The corporate contributions are fully deductible to the corporation and ‘top-up’ contributions must be made to provide an annual 7% return. Get advice as there are several conditions which must be complied with including a defined minimum salary to qualify to set up an IPP.
The designated HEAD OFFICE of the corporation will be your home address. You can get an annual non-taxable reimbursement from the corporation for its proportionate usage of your home and the corporation can deduct the payment as a rent expense and save 15.5% in taxes. Nice!
There is a taxable benefit called a “STAND-BY CHARGE” calculated when an agent is driving an employer–provided vehicle and the corporation is paying ALL vehicle expenses. The general calculation is two-thirds of the capital and operating costs but you can use a second calculation where the benefit corresponds to the ACTUAL personal usage which might be only 8% to 12% of total driving. Get Odotrack.
You can ’roll’ furniture, computers and vehicles into a corporation and the corporation will owe you an amount equal to their value.
William Howse B.A., LL.B. ( Barrister & Solicitor ) Adam Serota B. Comm., J.D. ( Barrister & Solicitor)
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