As news of house-flipping for profit continues to be reported in large Canadian cities, a recent Tax Court of Canada case sets out the factors a court will consider in assessing the taxation of real estate deals for homes that have never been lived in and sold for a profit.
The taxpayer is transit operator for the Toronto Transit Corporation. In 1999, the taxpayer and his brother bought a townhouse in Vaughn, Ontario and lived there together, contributing equally to household expenses and mortgage payments.
In 2006, the taxpayer decided he wanted to sell the townhouse and began looking for a smaller place of his own. He found and bought a two-bedroom condo that was in pre-construction. It was set to be ready in 2008; however delays resulted in that date being pushed back to 2010.
In 2008, his brother’s father passed away and their mother came to live with them in the townhouse. The taxpayer then refinanced the mortgage on the townhouse and bought out his brother’s share of the property. His brother moved out.
When the taxpayer finally took possession of the condo in 2010, he decided that it was too small to live in with his mother and immediately decided to sell it. No one ever lived in the condo.
He was able to sell the condo in October 2010, which resulted in a net gain of $13,412, which the taxpayer reported as a capital gain, taxable at 50 per cent, on his 2010 tax return.
The Canada Revenue Agency (“CRA”) reassessed him, finding that the $13,412 should have been reported as fully taxable income and levied gross negligence penalties under subsection 163(2) of the Income Tax Act (the “Act”), which imposes penalties for false statements or omissions.
The taxpayer appealed the CRA’s reassessment.
The issues were:
(i) whether the taxpayer’s $13,412 gain from the sale was business income from an adventure or concern in the nature of trade, or a capital gain; and
(ii) if the gain was business income, then whether the penalties levied under subsection 163(2) of the Income Tax Act were appropriate in the circumstances.
Tax Court of Canada Decision
The court stated that the question of whether a gain from the sale of real estate is on account of income or capital is a question of fact. Generally, a court will consider the surrounding circumstances and, specifically, the court must consider intention. The factors to be considered in such an assessment are as follows:
- The taxpayer’s intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.
- The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer’s business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.
- The nature of the property and the use made of it by the taxpayer.
- The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade.
The court noted that, with respect to intention, the Supreme Court of Canada has also said that an adventure in the nature of trade first requires a “scheme for profit-making” and that there must be a legitimate intention to gain a profit from the transaction in question.
After reviewing the facts andanalyzing the above factors and, in particular, that of intention, the court found that the sale of the condo was a transaction on account of capital. Based on this finding, the court also found that the gross negligence penalties were not applicable.
As a result, the court ruled that the taxpayer’s $13,412 gain from the sale of the condo was a capital gain and properly reported by him as such. Therefore, the CRA’s reassessment was vacated.
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