House Flipping: It is Declared as Business Income Or Capital Gains?

For those looking to get into the real estate business, especially when it comes to house flipping, it is important to understand the difference between capitals gains and business income.

When Flipping a House, What Tax Are You Obligated to Pay?

With the right type of renovations and knowing your real estate market, buying, and flipping a house can be a very profitable venture. However, it is important to note that if you are selling a house that is other than your primary residence, there will be taxes to pay.

Under the sale of your primary residence, you are exempt from paying taxes, allowing you to keep the full amount of the profits of the sale. Legally a primary residence is considered a property in which you or your family have normally inhabited.

Although there is no specific time period that you are obligated to dwell in your primary residence to consider it as “ordinarily inhabited”, however you may only designate one property per year and per family as a primary residence.

Even though you do not have to pay taxes on the sale of your primary residence, as of the 2016 tax year, you are required to report its sale in your annual income tax return, regardless if you are protected by the primary residence tax exemption.

However, if you are flipping a house that is not your primary residence, you will be required to pay taxes on the sale. The question on how much tax will you be required to pay will depend on a few different factors.

Designating a Property as Your Primary Residence

As previously stated, Canadians are not required to pay capital gains tax on the sale of their primary residence. Because of this exemption, some people try to get away with claiming the home that they flipped as their primary residence during the renovation period to avoid the tax. However, this is a tactic that the CRA is well aware of and they take stringent measures to prevent this from happening.

There is no legislation that requires you to live in a home for a specific period of time in order for it to be considered as “ordinarily inhabited”.

There are several factors that the CRA will take into account to determine if your property is considered a primary residence when you report the sale of your property in your personal income tax return. Some of these factors will include the following:

– Your intent at the time of your purchase
– What the time frame was between the purchase and the sale of the property,
– The number of home purchases and sales you have made over a period of time
– Your expertise and knowledge that you may benefit of due to your specific profession (whether you are a contractor or a real-estate broker),
– The number of primary residence designations you have made and other criteria the CRA may look at.

It is a very bad idea to flip a property and attempt to declare it as the sale of a primary residence on your tax return if this is not the case. The CRA will most likely find out about it which can result in some hefty tax penalties and interest owing if you get caught. It is definitely not worth the risk.

It is crucial that you accurately report the details of the sale of your property as this can affect whether you are taxed on capital gains on Canadian real estate or on business income. This can greatly impact the amount that you may end up owing if done incorrectly.

Capital Gains vs Business Income

You will most likely pay taxes if you sell a property that is not your primary residence. The difference in how much you will pay is dependant on how the CRA considers whether your profits are business income or capital gains.

How much do you have to pay in Capital Gains Tax? How to determine what you would have to pay on capital gains is fairly simple. Capital gains tax is charged at half the rate of your profit from the sale, therefore 50% of your revenue from the sale is what you will have to pay taxes on to the CRA.

Therefore, if you make a profit of $100,000 on the sale of your property, only $50,000 of that amount will be subject to capital gains tax. The actual amount that you will owe will be determined by your marginal tax rate for that year.

However, if the CRA determines that your profits are business income, then you would be required to pay taxes on the full $100,000.

Capital gains or business income: How does the CRA determine your situation?

The CRA uses many factors to determine what taxes you need to pay. The CRA will most definitively consider your profits as business income if they believe your intent was to sell the property for a profit.

The CRA will consider if you sold for profit or not by looking at pretty much the same factors it does to determine whether if your property is a primary residence. Therefore, as mentioned before, some of these factors will include how many properties have you bought and sold prior, the time in between purchases and sales, what type of renovations were done and so forth.

The profession you are in will also be a key factor in determining what tax you will have to pay. Certain professions, such as realtors, contractors, and builders for example, are in areas that are most likely to be considered to realize business income from house flipping.

Therefore, as you can see, depending on your situation, the circumstances can get very complicated. This can be a very tough financial situation to be in if you find yourself having to pay either capital gains tax or business income tax when this was not expected.

Disclaimer:
This article only provides information in a general nature and is only as current as the date in which it is posted. It is not updated and therefore may no longer be current. This document should not be relied upon as it does not claim to, nor provide advice on legal or tax matters. All tax situations are specific in nature and will likely differ from the situations that are presented in the article. It is advisable that you seek and consult a tax professional if you have any specific legal or tax questions. This document is intended to provide general information on a particular subject or subjects(s) and this article is not an exhaustive treatment of such subject(s). In accordance, the information in this document is not intended to constitute or replace accounting, tax, legal, investment, consulting, or other professional advice or services. Before any decision is made, or any action taken which might affect your personal finances or business, you should consult a qualified, professional adviser.