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Posted by Tax Consultants

Real Estate

2019 & 2020 House flippers in the overheated real estate market in Vancouver and Toronto and other parts of the country.

MK & Associated is a Chartered Professional Accounting firm specializing in disputes with Canada Revenue Agency (CRA) over Real Estate and high level Canadian tax matters and handles disputes with the CRA.

Our strong preference is to handle matters at the initial stages of a CRA audit rather than dragging it into court, which would be more costly to the taxpayer. At MK & Associates, we pride ourselves for having won most of our cases against the CRA. If you have not been successful with another firm and now face a Notice of Objection (NOO), rest assured that all is not over yet, and we have a high success rate with NOOs as well.

In recent years and surely in the year 2020 and the years to come, the Canada Revenue Agency (the “CRA”) has become more critical of real estate transactions claiming tax non-compliance has contributed to increasing housing prices.

The CRA has been examining “real estate flipping” (condos, attached homes, detached homes) more closely in recent years.

CRA has had a real estate audit project for several years, which could be GST/HST or for Income Tax purposes, or both. Generally, when they conduct an audit for one, they will also audit for the other. It is crucial to prove the first case so that it doesn’t trigger other audits.

CRA routinely researches City documents to identify any changes in ownership in real estate and compares that to your tax returns. They look for red flags, which include taxpayers incorrectly categorizing their taxable income to qualify for lower tax rates by claiming their real estate property as their personal residence (tax exempt), or capital gains treatment instead of income treatment.

The Income Tax Act does not have a rule for determining whether income is from business or capital gains. Instead, the courts have identified a number of factors, which may be considered. Some if the factors include:

1) The profession of the taxpayer

2) How long did the taxpayer own the property

3) The frequency and number of real estate sales the taxpayer has conducted

4) Money borrowed for the purchase of the property

The factors are directed towards determining the intention of the taxpayer, which is the central consideration in the classification of disposition transactions.

Similar factors to those used in classifying business or capital gains income apply in determining whether the principal residence exemption has been legitimately claimed. The principal residence exemption renders the sale of a taxpayer’s principal residence tax-free for the years it was his or her principal residence. The exemption can be claimed only where the taxpayer intends to and does ordinarily reside in the property.

Conversely, an owner may move into their property briefly before selling the unit just to claim the principal residence exemption on the sale. These claims of the principal residence exemption may be denied by the CRA as the flipper did not intend to ordinarily reside in the unit as his or her principal residence.

Real estate flippers must also be conscious of the impact of GST/HST taxation on the purchase and sale of their properties. As the purchaser, the flipper would like to claim the New Housing Rebate under section 254 of the Excise Tax Act. This rebate allows the purchaser of a new or substantially renovated home to recover a portion of the GST/HST paid on the purchase. However, the second requirement for claiming this rebate is the use of the home as the owner’s primary place of residence. Most house flippers fail to fulfill this requirement, and thus cannot claim the rebate.

Real estate flippers generally have GST/HST remittance requirements on the sale of their properties. GST/HST must generally be paid on the sale of a newly built or substantially renovated home. Flippers who are buying unbuilt or partially built properties then selling the units once completed will likely be caught by this rule and should be remitting GST/HST.

FALSE FLAGS: BYGRAVE V. THE QUEEN

 

The CRA’s efforts to catch flippers underpaying their taxes has wrongly ensnared taxpayers correctly reporting their taxes such as in the recent case of Bygrave v. The Queen. In 2006, Mr. Bygrave, a TTC operator, purchased a condo unit in the pre-construction stage, which he intended to move into once construction was complete. His plans changed when his father passed away and his mother came to live with him. The condo was not suitable for him and his mother, so he sold it without having lived in it. Mr. Bygrave reported his earnings from the condo sale as a capital gain. The CRA reassessed him, claiming the sale was “an adventure in the nature of trade” and Mr. Bygrave had earned business income from the sale.

The court applied a four-factor test to determine whether Mr. Bygrave had acted “in the nature of trade” and thus earned business income on the sale. The first two factors of the test, intention of the taxpayer and the nature of the taxpayer’s profession, both favoured Mr. Bygrave having not acted “in the nature of trade”. The nature and use of the property factor suggested Mr. Bygrave had earned business income. The final factor of whether borrowed funds were used and the length of ownership of the property was neutral. The court found Mr. Bygrave had been correct in claiming capital gains income instead of business income on the sale of the condo unit.

 

MK & Associates interview  by Tom McFeat, CBC

10 ways to attract a CRA auditor’s attention – Business: Tax Season – CBC News

We all like to be noticed.

But there are times when it’s best not to stand out from the crowd. One of those times is during tax-filing season.

Every year, however, some Canadians seem determined to attract the scrutiny of the Canada Revenue Agency and its army of auditors

And every year, the CRA’s spotlights are focused on people who have performed the income tax equivalent of waving a red flag in front of a bull. These taxpayers have painted metaphorical targets on their foreheads, stuck “audit me” signs to their backs and stood in front of the CRA’s radar dishes. They have, in short, dared the tax department to come calling.

So, what are some of those attention-getting triggers?

Here are 10:

  1. Ignoring the CRA’s requests for further information. So, the tax department has asked you to submit a receipt for that big moving or child-care expense you’ve claimed. Ignore them, you think. They’ll go away. Well, no, they won’t. “If the taxpayer does not respond on a timely basis or is unable to provide adequate support for a claim, the CRA will issue a reassessment, perhaps denying a claim completely or adjusting an income or expense figure based on the information on file,” says Ernst & Young. Failure to respond to legitimate requests for information can also flag your returns for audits in future years.
  2. Large or unusual changes in deductions or credits. The CRA’s computers like consistency. “Major changes in income or expenses or tax deductions from one year to the next will raise suspicion,” warns Barrett Tax Law, “so do try to be consistent in your declarations.”
  3. Claiming hefty home-office deductions. Trying to write off half of the costs of running your six-room house for your home-based business just invites CRA scrutiny. “To be able to exercise this deduction, you must use the space exclusively and regularly as your principal place of business,” says accountant Marvin Khoshkhassal of Vancouver-based MK & Associates. “That makes it difficult to successfully claim a guest bedroom or rec room as a home office, even if you also use the space to do your work.”
  4. Claiming 100 per cent business use of a vehicle. Claiming you don’t ever use your company car for personal use is a real red flag for CRA auditors since even driving from home to the workplace is considered personal use. PricewaterhouseCoopers points out that the CRA wants to ensure that “employees do not receive personal benefits tax-free, when salary, bonus and other forms of compensation would give rise to income tax.” So, detailed record-keeping is essential when using an employer-supplied vehicle.
  5. 194911

    The CRA’s system of matching the T-slip you’ve received with the one sent to the CRA by the employer is better than ever. (James Kost/Shutterstock)

    Not reporting income from a T-slip. The CRA’s system of matching the T-slip you’re sent with the one sent to the CRA by the employer or financial institution is better than ever. If there’s a mismatch, the computers will catch it, and your return will be reassessed. A penalty can be imposed for not reporting the income. Do that twice in a four-year period, and the penalties double.

  6. Reporting an income much lower than other residents in the same area. Reporting a $30,000 income in a neighbourhood of multi-millionaires just invites tax inquiries. “This suggests that an individual may have unreported income,” say the tax lawyers at Gowlings in an advisory. “Unreasonably, low reported income is not only an audit trigger but may cause the CRA to initiate a so-called ‘net worth’ or arbitrary assessment, whereby various tools are deployed by the CRA to impute income to the taxpayer.”
  7. Claiming an aggressive tax shelter. Tax shelters, which are designed to shelter income from tax that would otherwise be paid, aren’t nearly as prevalent as they once were. And those that are still, in effect, face strict rules. “Taxpayers are not allowed to engage in aggressive tax planning arrangements deliberately designed to circumvent the object and spirit of tax laws,” warns the CRA. So, RRSPs are fine. Gifting tax shelter arrangements, where taxpayers are given donation receipts that are for much higher amounts than the actual amount they donated, are not. Audits of these arrangements are guaranteed.
  8. Recurring losses from a rental property. You bought a rental property a few years ago, and it’s still cash-flow negative. So, you’re reporting a loss…again…which you plan to deduct against other income.

    ‘The CRA is quite aggressive in targeting rental loss deductions.’– KPMG

    “The CRA is quite aggressive in targeting rental loss deductions,” warns KPMG. So, you need to keep careful records that show you did your due diligence when buying the property and deciding on what rent to charge and don’t rent to a relative at a below-market price. The CRA knows that rental businesses, like all businesses, can take several years to turn a profit. But for losses to be allowed, there must be a reasonable expectation of profit down the line.

  9. Being self-employed. Having their own business can give some entrepreneurs the urge to over-report expenses and under-report revenues, and no one knows that better than the CRA. Working in an industry where cash frequently changes hands, like restaurants, can also up the odds of being given a fiscal cavity search. The tax department “has tools to investigate and gather information about your industry,” says Barrett Tax Law. “If your numbers don’t fit the typical profile, then chances are greater that you will be audited.” The Canadian Federation of Independent Business echoes that warning in its publication, What to do when the tax auditor arrives. It says small businesses are usually chosen for audit for a specific reason. “Perhaps your travel and promotion expenses look high or your profit markup looks low.”

    bank-investing-tax-season

    Having a lot of money in your TFSA account is a red flag for the CRA as it’s a sign you might be doing frequent trading inside the account and making large gains that should be taxed. (Todd Korol/Reuters)

  10. Having a large amount in a TFSA. Recent media reports say the CRA has been targeting holders of very large tax-free savings accounts (TFSAs)  those in the hundreds of thousands or even millions of dollars. The issue appears to be that some TFSA holders have been successful by being active traders within their TFSA, perhaps trading dozens of times a day. That appears to be a problem in the eyes of the CRA because taxpayers aren’t supposed to use their TFSAs to carry on a business  in this case, a trading business. “It seems clear that the CRA is intent on challenging those who have enjoyed significant growth within their TFSA,” warns tax law firm Thorsteinssons LLP. The tax department has reportedly been saying the gains in these cases should all be taxed. Look for this issue to head to court soon.

Most of the CRA’s 144,013 audits and/or examinations in the last fiscal year didn’t lead to criminal charges. But the tax scrutiny can still be costly and uncomfortable.

The good news is that there are steps you can take to minimize the fallout if you’ve done something wrong.