Flipping houses in Canada – the law and the taxes
In response to the affordable housing crisis in the Canadian real estate market, the federal government established two laws that address flipping houses in Canada and the assignment of Agreements of Purchase and Sale of pre-constructed homes
The proposed numerous measures from the Federal Budget are aiming to curb the flipping of residential real estate properties and set straight the imbalance in the real estate market.
These new laws have the potential to make it harder for real estate investors to obtain a profit through the flipping of properties and real estate contracts by introducing high tax rates on such activities with little to no exceptions.
This blog examines the new rules and reveals the consequences that arise as a result of these measures.
The Anti-Flipping Rule
In August of 2022, the Federal government published a draft legislation that introduced the new anti-flipping rule which ensures that any profit earned from a flipped property will be fully taxable.
Flipping a property refers to the act of purchasing real estate property with the intent to resell it within a short period of time with a view to earning a profit.
The current law in relation to the sale of real estate is as follows:
- Principal Residence Exemption. In Canada, if you are selling your primary home residence, the gain on the property is non-taxable. To be considered a primary residence, you, your spouse, and/or your children must be physically living in the property for at least part of the year.
- Capital Gain Tax. If you are selling your secondary property or a property that is not your principal residence (such as a cottage or rental property), the profits you realize will be taxed as capital gains. This means that only 50% of the gain your realized will be subject to tax and the remaining 50% will be tax-free.
The new Residential Property Flipping Rule will change this dynamic. Under this law, if you sell real estate that you have owned for less than 12 consecutive months, you will be deemed to have flipped the property. As a result, any profits earned will be 100% taxable as business income, even if the property is your principal residence. Since the government believes that flipping a property is a business activity and should be treated just like any other business venture, the profits will not be subject to the preferential 50% capital gain tax.
This rule came into effect on January 1, 2023, and will apply to any residential real estate sold on or after this date.
Are There Any Exemptions?
Fortunately, the federal government carved out some exceptions for extraordinary life events which include the following:
- Death
- Breakdown of marriage
- Birth of a child
- Serous disability of illness
- Relocation for work
- Bankruptcy or insolvency
In these situations, the profits from the sale of the home will not automatically be deemed to be business income. However, despite meeting an exemption or owning a property for over the 12-month period, the question of whether the property will be taxed as business income will remain a question of fact determined by the CRA. Thus, a homeowner can still be subject to a CRA audit and liable for the 100% taxable gain even though they meet an exemption or the time period.
Taxing Assignment Sales
In addition to the Residential Property Flipping Rule, the Federal Budget also included new rules in relation to another form of real estate investment: the assignment of Agreements of Purchase and Sale of pre-construction homes.
An Assignment Sale of pre-construction homes refers to the sale of the contract, the Agreement of Purchase and Sale which the assignor has signed with the builder, to a new buyer called the assignee. This type of transaction can also be considered to be a flip of real estate, but this type of flip takes place before the construction of the home is complete and before the original buyer takes possession of the home.
In this situation, the assignor (original buyer) has only provided the builder with a deposit to secure the real estate purchase. However, before the assignor occupies and takes possession of the home, he may assign the contract to an assignee (the new buyer) for a fee. The assignee then becomes liable for obtaining a mortgage and will become the legal title owner of the property once the construction is complete and the parties can close on the deal (please click here for more information regarding newly built home purchases). This fee may simply cover the original deposit, or this assignment price may be greater than the deposit. If the price is greater, the assignor earns a profit on the difference in the assignment sale.
Prior to 2022, the question of whether an assignment sale attracted GST/HST on the profit depended on each person’s individual circumstance. If the
- assignor entered into the Agreement of Purchase and Sale with the intention to use the property as a primary residence, the assignment sale would typically not be subject to the collection of GST/HST;
- assignor entered into the Agreement of Purchase and Sale with the intention to use the property as an investment and earn a profit, the assignment sale would be subject to the collection of GST/HST from the assignee and remitted to the CRA by the assignor.
The new laws in relation to assignment sales took away the fact-based analysis and made all assignment sales taxable, regardless of the purpose of the sale. More specifically, the Assignment Sale Tax establishes that assignment sales are subject to a 13% tax in Ontario on the assignment price of the home which the assignor must remit to the CRA. This rule also applies to substantially renovated homes.
All assignment sales conducted on or after May 7, 2022, are subject to this rule.
Builder’s Consent
In addition to this new rule, for an assignment sale to be legally allowed, the assignor must first obtain the builder’s consent to assign the contract. Typically, the original Agreement of Purchase and Sale signed between the assignor and the builder will have a clause that governs the assignor’s contractual right to assign the Agreement. If the agreement explicitly prohibits the assignment or the builder refuses to provide consent, the original buyer will not be allowed to assign the property to a new buyer.
This was confirmed in a recent 2022 Ontario case where the contract between the buyer and builder stated: “The ASSIGNOR shall request the consent of the Developer to this Assignment. The ASSIGNOR agrees to pay any assignment fees charged by the Developer and its solicitors if any, to obtain the consent of the Developer to the assignment plus any applicable taxes.” As the buyer in this case did not obtain consent, the buyer was prohibited from assigning the contract to a new buyer and was ordered to pay costs.
Consequences of the New Measures
Prior to these rules, real estate was a great source from which to gain a profit due to the minimal tax obligations. Investors with cash on hand could flip a property and benefit from the 50% capital gain tax exemption. Furthermore, investors without the ability to obtain complete funding for a home purchase could benefit from investing little amounts of funds into numerous properties by simply covering the deposits and then reselling the contracts through assignment sales prior to closing without the necessity of committing to the entire purchase price of the properties. With the establishment of new taxation rules, these advantages have slowly been taken away.
Not only do the new tax rules deter investors and assignors from purchasing homes and contracts for the purpose of flipping them, but the rules also deter potential buyers from taking on assignments.
The anti-flipping tax ensures that there will be a decreased profit margin for the sellers which may make flipping homes less profitable or even non-profitable.
In terms of the assignment sale, assignors may attempt to have the assignee pay the HST on the assignment sales to recover costs, however this will likely deter buyers instead. As a result, the assignors will have to pay the 13% tax on the profit from the assignment sale and unless the price of the property increase by more than 13%, they will lose on the sale. In the worst-case scenario, the builder does not consent to the assignment and the buyer will be forced to close on all the properties in which they invested their deposits; something that they may not be able to do financially (please click here for more information on the consequences of failing to close your real estate deal). In this event, although you may avoid the 13% GST/HST, you will consequently trigger the anti-flipping tax and be taxed on 100% of your gains.
The Help of a Real Estate Lawyer
While the new rules proposed by the federal government are made to benefit homeowners by cooling down the real estate market, they also place a significant burden on those who try to navigate through the constantly changing water of the real estate world. Since serious financial and legal implications can arise if you are uninformed about the technicalities of real estate law, it is best to advise an experienced real estate lawyer who can guide you through your home purchases and sales.
If you require any assistance with your real estate transaction get in touch with us at Beffa Law and we will be able to help you navigate through the rough waters of the real estate world and achieve the results your desire. Beffa Law is a real estate law firm serving customers in Greater Toronto Area and beyond. We offer assistance in buying, selling, refinancing along with other practice areas. Call us at 647-812-8462 or email us at info@beffalaw.ca to set up an appointment to discuss your estate questions or concerns.
