Written by Colin Younker, FCPA | MRSB Chartered Accountants Inc.
Real estate transactions probably produce the majority of disputes as to whether a gain or loss on a sale is capital in nature or should be treated as ordinary income or loss. There is no provision in the Income Tax Act which describes the circumstances in which gains or losses from the sale of real estate are determined to be either income or capital.
As announced in the 2019 Federal Budget, CRA was to be provided $50 million over the next five years, starting in 2019-2020, to create a Real Estate Task Force to audit real estate transactions. The focus of the task force is to ensure that:
- Taxpayers report all sales of their principal residences on their tax returns,
- Money made on real estate flipping is reported as income, and
- Any gain derived from a real estate sale where there is no principal residence exemption is a taxable transaction.
CRA is projecting significant revenue from this initiative over the five-year period.
During an audit, the CRA considers a number of factors to determine the nature of the tax treatment of any gain or loss realized. These include:
- Type of property sold,
- How long the property was held,
- The seller’s history with similar properties,
- Whether any work was done on the property,
- Why the property was sold, and
- The seller’s original intention in buying the property.
Interpretation Bulletin – 218R outlines many of the factors the Courts have considered in making decisions as to income versus capital gains treatment of real estate transactions including:
- The taxpayer’s intention at the time of purchase,
- Whether that intention was feasible,
- Location and zoning of the real estate,
- Extent to which the intention was carried out by the taxpayer,
- Any evidence that the intention changed after purchase,
- The extent to which borrowed money was used to finance purchasing the real estate and the financing terms,
- The nature of the business, profession or trade of the taxpayer and associates,
- The length of time throughout which the real estate was held,
- Factors which motivated the sale, and
- Evidence that the taxpayer and/or associates had dealt extensively in real estate.
Two court cases illustrate that to determine whether the tax treatment of real estate transactions is capital or income is complex and not black and white. In the first case, Wall v. The Queen (2019 TCC 168), there were four properties at issue: three houses and a vacant lot. The Court’s ruling was that the sale of the houses was income and the sale of the vacant lot was capital.
The Court summarized some of the tests noted above but also discussed the “secondary intention” test. Even though the purchase of a property was intended as long-term investment (a capital use) at the time of purchase, if the taxpayer also had in mind of selling the property if the investment use did not materialize, the Court can determine that a future gain or sale is income.
In this case although the taxpayer was a real estate developer and was flipping the houses, CRA still conceded and the Court agreed that the original assessment of the gain on the vacant lot sale as income would be reversed and be re-assessed as a capital gain.
In a second case, Bygrave v. The Queen (2019 TCC 138), a gain from the sale of a property upon completion was not considered as income but as capital gain. The two factors relied on in this case were that the intention of the taxpayer changed due to a major unexpected change in circumstances and due to the taxpayer not being an expert in real estate.
Interpretation Bulletin – 218R also outlines specific considerations with respect to farmland and inherited land recognizing the possible difficulty of selling the land ‘en bloc’. A gain on the sale of farmland or inherited land even where there has been a subdivision plan filed may still be a capital gain until the taxpayer goes beyond mere subdivision – puts the “shovel in the ground” and installs watermains, sewers or roads, or commences significant advertising to sell lots.