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Articles

By Fabio Campanella CPA, CA, CFP, CIM

Property Fix and Flips: What You Need to Know

So, you’ve purchased a property, renovated it, and flipped it for a profit. How do you report this on your tax return?

Well, it depends…

The housing market in Canada, particularly in Toronto and Vancouver have been hot for over a decade. Naturally this has attracted investors looking to profit off the upward swings in prices. Some investors adopt a “buy-and-hold” strategy while others prefer a quicker turnaround.

This article focuses on the quick turnaround, or a “flip” defined for the purposes of this article as: the purchase of an existing piece of real estate followed by the improvement or reconstruction of the real estate with the view to profit from the augmentation in a relatively short period of time (0-3 years).

This article does not consider pre-build condo assignments.

Many taxpayers consider a piece of real estate to be a capital property subject to the capital gains/losses provisions of the Income Tax Act but this is not always the case. Capital gains are taxed at half the normal rate of regular or business income. There is therefore a large incentive for taxpayers to seek capital gains treatment on their investments as this treatment may lead to a tax savings of 25% or more depending on the province of residence.

A gain arising on the sale of a piece of real estate may be business income, property income or a capital gain. The Income Tax Act does not have a provision defining the conditions for each of these treatments. We must therefore go to the courts to help us decide. Historically the courts have considered several conditions including:

  • The taxpayer’s original intentions with respect to the property
  • The taxpayer’s profession
  • The amount and terms of borrowing used to finance the purchase of the property
  • The length of time the property was held
  • The existence of other individuals who share interest in the property
  • The taxpayer’s level of sophistication with respect to real estate

When determining whether a sale is on account of capital or business the taxpayer’s intention is of utmost importance. If the taxpayer’s intention was clearly to sell a property for a profit quickly then it is likely that the property will be considered an inventory and the gain will be classified as business income subject to full taxation. The other conditions above will come into play as well.

For example: Mr. A, a licensed realtor, purchased a property with a co-ownership agreement between himself and two other associates. The group took a short-term private mortgage to finance the purchase of the property and renovation costs. Upon taking possession of the property the group engaged a contractor to make improvements to the property over the course of three months. At the completion of the renovation the group engaged a staging company to outfit the property with furniture and artwork. The taxpayer subsequently listed the property for sale and it eventually sold for a substantial profit. 6-months in total elapsed between the purchase, renovation, and sale of the property.

In this case the following facts are presented:

  • The taxpayer’s original intention was to purchase the property and sell it for a profit
  • The taxpayer’s original intention was carried out
  • The taxpayer’s profession as a licensed relator gives him professional insight into the real estate market
  • The taxpayer involved other individuals in the transaction
  • Renovations and staging were used to increase the market value of the property
  • The holding period is short-term

The fact pattern above clearly leads to a business income treatment as many of the conditions weigh heavily in that direction. In this case it would be reasonable to expect to pay full tax on the gain.

Let’s change the facts:
The taxpayer, Mr. B, an IT professional with no experience in real estate purchases a property with the intention to lease it to a tenant under a long-term contract. Mr. B purchases the real estate using conventional bank financing and engages a contractor to simply repair a damaged roof and update the property’s kitchen to make the property more attractive to potential tenants. At the end of the contractor’s work (2-months) Mr. B engages a realtor to list the property for lease. The property is listed for a period of 3-months unsuccessfully. During this period Mr. B loses his job and is not able to secure additional employment. Mr. B can no longer afford to carry the costs on the home and without employment his bank is unwilling to provide the financing to do so. Mr. B instructs his realtor to list the property for sale. It is sold within a month for a profit, Mr. B pays significant penalties to break his mortgage.

In this case the following facts are presented:

  • The taxpayer’s original intention was to hold the property for a long-term
  • The taxpayer did not have a secondary intention when purchasing the real estate as he was willing to cover the carry-costs on the real estate until it was leased and originally had the means to do so
  • The taxpayer’s original intention was not carried out due to legitimate limiting factors
  • The taxpayer made attempts to carry out his original intention (listing the property for lease, attempts to obtain additional financing to cover costs)
  • No other individuals were involved
  • The taxpayer’s profession is not related to real estate
  • The holding period is short-term

The fact pattern above is not as clear cut as our first example. Mr. B has a much stronger argument for capital gains treatment than Mr. A above. However, this does not guarantee capital gains treatment as the Canada Revenue Agency may argue Mr. B had a secondary intention to sell the real estate at a profit should his first intention fail. The onus of proof would be on Mr. B to clearly demonstrate his intentions.

As we can see the treatment of property flipping is not clear cut. Each case must be dealt with on a case-by-case basis using the facts of each individual situation.

At Campanella McDonald LLP we help small business owners, self-employed professionals, and real estate investors maximize their bottom lines by providing value-added tax, accounting and financial advice. Our partners and staff have been advising clients on real estate investment matters since 2002. In addition to tax advice the firm has a dedicated team including investment focused realtors, mortgage brokers and financial planners that help clients design, implement and monitor their real estate investment portfolios from novice to seasoned experience levels. For more information you can email us at info@cmllp.com, or call 647-557-2935 ext: 101.