Flip with Care: Watch Out for Principal Residence Rules

There’s nothing like a good house flipping show to get you thinking about the cash potential in your own home. The house flipper approach is to buy homes, live in them short-term while fixing them up, and then sell them; often for big profits. It sounds simple, but it’s not a foolproof strategy, because it comes with tax risks. When done often, house flipping can raise eyebrows at the CRA. Learn how to flip with care, and understand the principal residence rules that could diminish your profits, or worse.

Though the housing market has recently cooled somewhat, the deposition of real property still has the potential to be very lucrative. This is especially true if you earn one tax-exempt capital gain after another using your principle residence exemption. But it’s not a claim that’s guaranteed – there are, in fact many grey areas in the burden of proof all taxpayers have in their relationship with the CRA. It’s important to understand these ahead of tax filing season. 

In the case of the sale of your principle residence, the CRA looks at your intention at the time you purchase the home as well as how many times you made similar transactions. If you buy and sell real estate too often, the CRA may disallow your claim for the principal residence exemption. Even worse, they could disallow the capital gains treatment that comes with a 50% inclusion rate. This circumstance requires the reporting of 100% of the gain as a gross profit if they get the impression you’re in the business of buying and selling homes. 

So where is the line drawn that determines whether profits are tax-free or classified as business income? The more closely your business or occupation is related to commercial real estate transactions (i.e. if you are a real estate broker or builder), the more likely it is that any gain realized from such a transaction will not qualify for the principal residence exemption at all and be considered business income rather than a capital gain.

The courts have considered some of the following criteria on a case-by-case basis to guide us in assessing the right tax filing requirements.  

Checklist for Determining Tax Attributes of Real Estate Dispositions:

• The taxpayer’s intention with respect to the real estate at the time of its purchase
• Feasibility of the taxpayer’s intention
• Geographical location and zoned use of the real estate acquired, extent to which these intentions were carried out by the taxpayer
• Evidence that the taxpayer’s intention changed after purchase of the real estate
• The nature of the business, profession, calling or trade of the taxpayer and associates
• The extent to which borrowed money was used to finance the real estate acquisition and the terms of the financing (if any) arranged
• The length of time the real estate was held by the taxpayer
• Factors which motivated the sale of the real estate
• Evidence that the taxpayer and/or associates had dealt extensively in real estate

Your principal residence can be a great source of wealth, especially if you can use the principal residence exemption to pocket tax free accrued gains. But a warning to potential house flippers – know the tax rules. Your principal residence exemption may be at risk if you don’t follow proper tax filing procedures. And keep this important tax fact in mind: all principal residence dispositions, whether tax exempt or not, must be reported on your personal tax return.  

Excerpted from Essential Tax Facts by Evelyn Jacks, 2018 edition. The new 2019 version is available for pre-order by calling 1.866.953.4769 now.

Additional educational resources: For help dealing with complex tax filing issues, consult a DFA – Tax Services Specialist™. Or, take matters into your own hands and enrol in the Tax Strategies for Investors certificate course. A free trial is available!

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