Written on behalf of Feigenbaum Consulting
As real estate values continue to explode in major urban centres across Canada, real estate transactions are becoming subject to increasingly greater scrutiny, including by the government. The Canada Revenue Agency (CRA) is analyzing more than 2,500 real estate transactions involving pre-construction condominiums as the agency attempts to crack down on tax evasion.
What is Shadow Flipping?
Shadow flipping occurs when a condo is purchased from a developer and sold to another buyer before the unit is completed.
This practice is controversial, as it allows real estate agents to make two or three times their standard commission by reassigning a sale to further owners at increasing prices.
Shadow flipping first made headlines in 2017 after a number of real estate transactions using “assignment clauses” became subject to scrutiny in Vancouver. An assignment clause allows a buyer to transfer or sell his or her interest in the property before the closing date. In some cases, real estate agents use this clause to basically sell the same home more than once, allowing them to collect multiple commissions from the same property.
By way of example, a real estate agent may find a buyer willing to purchase a home for $3 million (Buyer 1). Another buyer may then buy the contract for $3.2 million (Buyer 2). Ultimately, a third buyer may purchase the contract for $3.4 million. In such a situation, Buyer 1 and Buyer 2 each make $200,000 in profit, and the real estate agent makes three commissions. However, the seller would only get the $2.5 million (minus commission). The flippers would pay tax on any profits made, but would pay no land-transfer taxes as assignments are not registered with the land-title office.
The CRA’s interest in investigating real estate transactions likely stems from the current affordability issues in many Canadian cities.
How is the CRA Conducting its Investigation?
Last July, the CRA obtained two court orders related to large condo projects in Vancouver. Since then, it has applied for two more, and has also begun to focus on Toronto. The agency is seeking information that would help it identify individuals who buy and sell presale condos before buildings are completed, and wants “any an all correspondence, including emails” between any parties involved in certain transactions, including developers, buyers, and agents.
The CRA notes that “from past experience” the agency knows that profits from assignments may not be reported for income-tax purposes.
The agency’s job is complicated by the fact that it cannot use the land title office, or any other source to which the CRA may have access to identify the people who sell or assign their contracts.
Individual developers will track flip transactions, which may involve a fee for developers, but that information is not public. The Globe and Mail reports that developers who have been targeted by the CRA so far say that they want to co-operate with the CRA, but must also be cognizant of privacy laws, and will, therefore, release information only under court order.
The CRA has said that:
Over the years, CRA has made significant progress in using intelligence gathered through a variety of tools at its disposal as well as using experienced audit and investigations teams. New technologies and faster computers are helping us to more effectively access, integrate, and analyze this data, resulting in better business intelligence
It is difficult to determine the scope of potential tax issues resulting from presale flips as the CRA doesn’t track any statistics specifically related to this. Information from other sources provides some idea of the scale of this practice. For instance, the president of the Urban Development Institute estimates that about five or six percent of overall condo sales in a given year are assigned or flipped. A real estate consulting firm notes that only 3% of all high-rise units in preconstruction and scheduled for completion between now and the end of 2022 remain unsold.
We will continue to follow developments in this and other tax-related news, and will provide updates as they become available.
In the meantime, if you have questions about tax audits, or compliance with your tax obligations contact Mark Feigenbaum for a custom solution to your personal tax needs. We work with you to streamline your compliance requirements. Contact us to learn more about how we can help or call us at (905) 695-1269 or toll free at (877) 275-4792.