Canada has a major deficit problem, and a huge national public debt, and both the Conservative government and the CRA are about to do something about it.
Tax laws are already very tricky when it comes to investing versus living, and especially when it comes to property ownership. When you’re living in a principle residence, if you ever sell it there is no tax on the money you make in the deal. If however you’re an investor and you make money from that home, it’s quite different and this is where it gets complicated. That’s because while some capital gains made from investments are not taxed heavily, any investment income is. Unfortunately, some investors aren’t paying those taxes, and with so much attention surrounding taxes (and even more so, those who avoid them,) the CRA is after them.
To be clear, you will be taxed on capital gains made on your investments, but those taxes are much lower than what you’ll have to pay if that same gain was considered to be income. If your gain is only $100,000 and your tax bracket is 46%, the capital gain would be taxed at 50% and you’d be responsible for paying $23,000 in taxes. However, if that same gain was to be considered as income, that amount would more than double, and you’d have to pay $46,000. And if you don’t fess up to the income, but try to claim it as capital gain instead, you’ll also face another 50% penalty – meaning that anything you’ve made off your investment has just been eaten up by the federal government.
Sam Papadopoulos, senior public affairs advisor-manager with CRA says that this sector is really hot right now; and therefore it’s attracting a lot of attention.
“We do from time to time target some sectors more closely than others,” he says. “We look at the real estate market in general. Of course, there is more focus, it’s a hot market.”
But these taxes come most into play when you’re talking about flipping properties – especially if you’re going to do it on a condo, and before the building is registered.
What happens in these situations is that an investor will come in and scoop up a few units within a condo building, based on specs as ground typically hasn’t even broken when the deal is made. Before the building is even registered the investor will sell their right to buy that condo, and keep any tidy profits they make in the process.
It’s an extremely lucrative strategy for investors; and builders too, seeing as how they collect a fee from the investor to allow them the privilege of doing so. But the proble is that once the building is registered with the land registry office, any information regarding the initial investor is nowhere to be found.
This strategy is so profitable, and that’s one of the things CRA is concerned about. This system, which is known as assigning property, hides millions of dollars in income from the government; and that’s unfair to all Canadians.
“If you keep assigning property,” says Mr. Papdopoulous “then it is not capital gains. That’s trade, and that’s income. You do it a couple of time, and it’s income. Of course, that’s part of what they’re investigating.”
Robert Kepes, a Toronto tax lawyer at Morris Kepes Winters, says that the concept of what’s capital gains and what’s income might be difficult for investors to understand. But, he says, just think of it as a fruit-bearing tree.
“The tree is capital and it produces a fruit and the income is the profit that is derived when that fruit is sold,” he says. If however, one day you decide to sell the tree, any funds received will be considered a capital gain, as the tree was always the capital. But, if you’re in the business of trading trees, that’s income too.
He says that one thing investors will have to do, especially if they’re being investigated by the CRA, is to prove that the property in question was a principle residence. If not, any money made from it is likely to be deemed as income.
“The Income Tax Act asks what was your intention when you bought that condo,” he says. “These principles are easy to describe but harder to prove in fact. We have to bring all kinds of intrinsic evidence.”
He says that sometimes this is something as simple as showing a driver’s license with the property’s address on it.
Brian Johnston, chief operating officer at Mattamy Corp. says that investors and buyers need to be very careful, and shouldn’t be caught in the trap of thinking that the government won’t find out about their property, or the fact that they profited from it.
“They audit real estate companies, look at the name on the contract and look at the final deed and see a difference,” he says. “They see Bill Smith bought it and Joe Blow is on the deed. They want to know how this happened and they follow the paper trail.”
But he says, sometimes the government is searching for people and investors that had no idea they did any wrongdoing.
“I think the government should make it a little simpler in terms of filing for principle residence exemption,” he says. “It’s a real grey area of law. The government has not done a good job for Canadians trying to specifically identify all the rules around selling homes and paying taxes. People might have inadvertently made mistakes.”
Brad Lamb though, says that he’s been audited several times, and that investors always need to err on the side of caution when it comes to dealing with the CRA.
“If you are a prolific buyer or seller of properties, whether it’s condos or not, you have to govern yourself accordingly,” he says. “If you don’t, you’ll get caught and be fined. I decided many years ago when I started buying condominiums, after talking with my accountant, you can pay lower tax or you can fight 50 years with Revenue Canada.”