8 Common Tax Misconceptions about Selling Real Estate
By All Access Homes
February 5, 2024
8 Common Tax Misconceptions about Selling Real Estate
Navigating the intricacies of real estate taxation can be tricky, and unfortunately, it's not uncommon for people to misunderstand tax laws related to property sales. We'd like to set the record straight so you can avoid unexpected tax headaches, stay compliant, optimize your finances, and enjoy peace of mind.
Here are eight common tax misconceptions about real estate.
Tax when Selling Real Estate: The Law (Simplified)
If a person sells a property, the tax treatment of any resulting gain (or loss) depends on whether the property was what tax professionals call “income property” or “capital property.”
An income property is generally purchased to resell for a quick profit or, as some people in the real estate industry would say, “flip.” The sale produces business income (or loss) and is taxed at a full tax rate. If a new or substantially renovated property is involved, there may also be harmonized sales tax (HST) implications.
A capital property is purchased to hold it as a capital investment and earn income from it. A sale of your capital property results in a capital gain (or capital loss). Capital gain is taxed at one-half of regular tax rates.
In simple terms, your intention at the time of purchase is key when determining whether the property is your business or capital property.
If you sold your capital property, which was also your family’s personal residence, the gain might be exempted from tax by the “principal residence exemption.”
While many people claim to be familiar with the law, the following are the common misunderstandings about its application.
Misconception #1: Living in Your Home Guarantees Tax Exemption
Contrary to popular belief, it is not enough to simply live in a property to qualify for the “principal residence exemption.” Principal residence exemption will not be available if the property was not your capital property, even if you lived in it. If you purchased a property with the intention to resell it for a profit, the resulting gain is taxable as business income, regardless of whether you lived in the property or not.
If, however, you purchased a property intending to live in it for a long time, the property is your capital property, and a principal residence exemption may be available if all other exemption requirements are met.
Misconception #2: It is Enough to Declare My Intention to the Canada Review Agency (CRA)
The CRA will assume your intention based on how, when, and why you purchased, held, and sold the property. More specifically, the CRA will look at your:
- Financing arrangements
- How long you held the property
- How you used the property
- Your history of similar transactions
- Reason for sale
- And many other factors
If the CRA finds that you intended to resell the property for a quick profit, and you disagree, the burden is on you to prove your position using your evidence. Simply declaring one’s personal intention is usually not enough to change the CRA auditor’s mind.
Misconception #3: Single Property Owners are Exempt From Paying Taxes
Owning only one property does not automatically qualify it as your capital or principal residence, as discussed in Misconception #1 (above).
For example, let's consider a scenario where a house renovator acquires a property to make improvements and eventually sell it for a profit. The renovator chooses to live in the property to reduce living expenses during the renovation process, given they have no other real estate holdings. The renovator sells the property at a profit as soon as the renovations are completed. In such a case, the renovator will not be eligible for the principal residence exemption because the property is not a capital property. The renovator will pay tax on business income at full rates.
Misconception #4: Holding Property for Over a Year Guarantees It as Capital, and Only Capital Gains Tax Applies.
No bright-line rule in the law would guarantee a certain tax treatment based on the number of years a person has held a property. In general, a long holding period indicates that a property is a capital property, whereas a short period indicates a business transaction. However, there are exceptions to every rule.
For example, a person can sell his house after four months of ownership because of an unexpected job relocation and qualify for capital property treatment and a principal residence exemption.
On the other hand, a person may purchase a property with the intention to resell and renovate it for three years before selling. The property is income property, and any gain is taxed as business income despite the three-year holding period.
Misconception #5: Selling My Principal Residence Means No Tax Declaration is Necessary
Individuals who sell their principal residence in or after 2016 have to report the sale on Schedule 3, Capital Gains of the T1 Income Tax and Benefit Return. For dispositions in 2017 and later years, in addition to reporting the sale and designating your principal residence on Schedule 3, you also have to complete Form T2091(IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust).
If you forget to make a designation of principal residence in the year of the sale, it is very important to ask the CRA to amend your income tax and benefit return for that year. The CRA accepts a late designation in certain circumstances, but a penalty may apply.
Misconception #6: Owners May Sell an Unbuilt Condo Through Assignment Without Paying Tax
“Selling on an assignment” is a phrase used in the real estate industry to describe an assignment of an agreement of purchase and sale for a property still under construction by the original purchaser to a new purchaser before closing.
As an assignor, you are selling something valuable: your right to a contract allowing you to purchase the property for a specific price. Any income you earn is subject to income tax and, in certain cases, may have HST implications too.
The tax treatment, again, depends on your intention at the time of entering into the agreement of purchase and sale. If your intention was to resell the property for a quick profit, the gain from an assignment is treated as business income. If your intention was to purchase a long-term investment, the gain from an assignment is a capital gain.
Misconception #7: My Neighbor Bob Avoids Taxes While Flipping Houses – The CRA Isn't Vigilant Enough
The CRA has been working very hard, employing the latest technology to identify people like Bob. The audits in the real estate sector resulted in over $1 billion in additional tax revenues from 2015 to 2018 alone. The 2019 federal budget proposed providing the CRA $60 million over five years to create a Real Estate Task Force to identify non-compliance behavior.
If Bob is audited, he will likely face serious consequences. He should talk to a tax lawyer.
Misconception #8: Self-Handling Communication with a CRA Auditor Saves Time
We generally do not recommend handling CRA audit communications on your own. Anything you say to a CRA auditor can be used against you. Let a tax law professional handle your audit correspondence with the CRA or, at the very least, obtain a consultation. DIY audits often result in unnecessarily difficult and expensive tax litigation matters.Why Settle for Ordinary When You Can Experience Extraordinary Living?
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