Be clear with your intent, especially when it comes to real estate. Given the new levels of heightened scrutiny by the Canada Revenue Agency (“CRA”) here in B.C., where real estate transactions are being targeted, it would be wise not to try and “cheat” the tax-man. It is amazing how many individuals do not report capital gains or taxable transactions to the CRA, ready to play Russian roulette with their livelihoods and income streams to avoid tax. Not surprisingly, however, is the number of real estate transactions offside for various tax purposes with the CRA, which are not looking to gain an unfair advantage, but often due to misinformation and poor advice.
A very good tax court case in November 24, 2017 (DaCosta et al. vs. H.M.Q., 2015-3549(IT)G), illustrates these problems. At stake is the two separate dispositions of condominium units which were reviewed to determine the following issues:
· Should the profits on the sales of the condo’s be taxed as income or as capital gains?
· Should the profits be reduced by expenses incurred to sell the properties, which were initially denied by the CRA?
· Were the individuals who sold the condo’s grossly negligent in failing to report the capital gains?
Before moving on with this case, which is extremely relevant to similar transactions here in B.C., there is a little background which in the preamble of the court case must be quickly discussed. The individuals in court were a grandmother who we shall call Cathy, and her granddaughter who we shall call Diana. In 2006, when Diana was 17, Cathy and Diana each signed a contract of purchase and sale to acquire a condo in a building that was being constructed in Toronto. Diana’s contract was for Unit 5 and Cathy’s contract was for Unit 6, with both units closed in June 2010. Subsequently, Diana sold her Unit 5 in June 2010 and Cathy sold hers in July 2010.
Of course, proper documentation was not exactly kept and the proceeds from the sale of the condo’s were never reported to CRA. Unfortunately, for both Cathy and Diana, CRA reassessed both of their 2010 personal tax returns and reported the gains from the property sales as failure to report business income.
The most interesting point here is that CRA reassessed Cathy and Diana with business income from the sale of the properties and not taxable capital gains. How is this possible you would ask? It does come down to a combination of facts, but the overriding issue here is intent. Cathy’s original stated intention to the Court was to rent out the property to a third party and Diana’s intention was to move into the condo to attend a nearby College.
It is interesting however that the stated intentions did not reflect the actual facts nor the reality of what Cathy and Diana did with their condo’s. At the time Cathy and Diana entered into the contract to purchase their condos, the Court noted that Cathy had a significant mortgage, line of credit, and credit card debts. She did not have the resources to fund her purchase, much less to assist Diana in the purchase of her condo. Cathy had been a realtor for 18 years and should have been well aware of the need for financing. As well, at the time of the purchase, Cathy obtained unconventional short-term loans, and the proceeds from the sale of Diana’s unit were used to help close the purchase of Cathy’s unit. Cathy’s unit was also listed for sale, even before Cathy took possession.
The Court found that Cathy’s intention was to sell the unit at a profit, and Diana’s intention was to simply do whatever Cathy wanted. It noted that this was not a situation where the taxpayers planned to hold the property on a long-term basis and some unexpected event frustrated that intention forcing them to sell. Thus, as the intent was never to hold the properties long term, but rather sold instantly with the view to a gain, the nature of the transactions were more business and thus were to be taxed as such instead of as a capital gain.
With regards to the other two issues at stake, Cathy and Diana were never able to deduct any expenses incurred, other than those that were obvious in the process of selling, as they both were unable to provide adequate documentation. Cathy was also assessed a gross negligence penalty in failing to report the income from the sale.
At the end of the day, make sure that you are clear with your intent in your real estate transactions, be aware of what is a taxable capital gain and what could be potentially business income as your tax liability significantly increases. Also, make sure you keep all documentation and plan with your tax obligations so that you are not resorting to potentially a series of events with unfavorable consequences.