Anti-flipping proposal may get bogged down with exemptions

This article will appear in the forthcoming May issue of Investment Executive.

Ottawa’s proposed new anti-flipping rule represents a significant change in real estate taxation, providing the Canada Revenue Agency (CRA) with clarity regarding when profits on a home sale are subject to full taxation and limiting access to the principal residence exemption (PRE).

Under the proposed rule introduced in the 2022 federal budget, an individual who sells a residence within 12 months of acquiring it will be deemed to have flipped it unless they qualify for an exemption due to a “life event.” Any profit from the sale of residential real estate (including rental property) within a year would be taxed as business income and be ineligible for either the 50% capital gains rate or the PRE.

Under current rules, if the CRA thinks you’re flipping houses, they must argue that was your intention, said MaryAnne Loney, a partner with McLennan Ross LLP in Edmonton. Under the proposed rule, “if you’re under a year and you don’t fall into one of those carve-outs — that’s it, you have business income, there’s no further debate.”

Armando Minicucci, a tax partner with Grant Thornton LLP in Toronto, said the proposed rule, with its defined time threshold, gives the CRA “clarity” in deeming profits from a sale as business income.

Tax experts suggest, however, that the anti-flipping rule is unlikely to achieve the government’s stated goal of curbing speculation. Taxpayers will work around the new rule, either by delaying the sale of a home beyond a year or by attempting to qualify under one or more of the eight life-event exemptions.

“There are so many exemptions that it’s hard to see how this is going to apply to too many people,” said Mike Moffatt, assistant professor with Ivey Business School at Western University in London, Ont.

Said Loney: “I think you’re going to end up with a lot of people who are selling at 13 months who might have otherwise sold earlier.”

Under the proposed rule, life events that qualify for exemptions include property sold in cases of death, disability, the birth of a child, a new job, divorce, insolvency, personal safety or natural disaster. The government indicated that details regarding the exemptions would be set out in upcoming rules and that it would consult on draft legislation, which is pending.

The government could still tax profit from the sale of a home as business income if the property is sold after a year or a homeowner is eligible for an exemption, but would have to make the case that the seller was flipping. That can be a heavy burden and take a lot of time, Loney said.

In the budget, the Liberal government argued that “property flipping — buying a house and selling it for much more than what was paid for it just a short time prior — can unfairly lead to higher housing prices.” The proposed anti-flipping rule would “ensure profits from flipping properties are taxed fully and fairly.” The proposed rule would take effect Jan. 1, 2023.

In an email to Investment Executive, a spokesperson for the Canadian Real Estate Association said it was seeking more information about the anti-flipping rule and the implications, but did not say whether the association supported the proposed measure.

Moffatt suggested the exemptions could make it challenging for the CRA to administer the rule: “Whenever you come up with subjective rules that force CRA to make a decision, [the agency] can get themselves into trouble.”

The CRA could take a lenient approach, Moffatt suggested, and “wave through a bunch of borderline cases,” compromising the effectiveness of the proposed rule, or take a stricter approach and risk denying an exemption “that they should allow — and you know that’s going to be a front-page story.”

The government’s proposed anti-flipping rule fits with measures taken in recent years to enforce eligibility rules governing the PRE. Beginning in 2016, for example, the government began requiring taxpayers claiming the PRE to report details of the sale in their annual tax return. Previously, if a property was a taxpayer’s principal residence for every year they owned it, they didn’t have to report the sale on their tax return to claim the PRE.

“The CRA had no insight into what was going on out in the market” prior to the reporting change, Minicucci said.

In recent months, the government has sent education letters to individuals who may have applied the PRE in error, providing the taxpayers with the opportunity to correct or amend their returns.

The PRE is an expensive measure for the government in terms of forgone revenue, said Dino Infanti, a partner and national leader, enterprise tax, with KPMG Canada in Vancouver. Considering the significant gains realized in the housing market in recent years, the government is trying to ensure that those who are claiming the PRE are, in fact, eligible.

Minicucci said the CRA may have some justification for the new anti-flipping rule, “as much as I hate to admit it. By keeping it to 12 months, you’re narrowing [application of the rule] to people who are blatantly in the market to flip properties.”

Nevertheless, the rule could hurt people who sell homes but are not engaging in flipping, Minicucci said. He cites the example of a client who sold a cottage in 2021 within a year of purchase after they realized “cottage life just wasn’t for them.” With the recent run-up in prices, the client sold the property for significantly more than what he paid, resulting in a capital gain. Under the proposed new rule, because the client had sold within a year, the profit from the sale would have been fully taxable as business income.

Moffatt expressed skepticism about the effectiveness of the proposed rule, saying that most speculation occurs on secondary properties, not primary residences, and that the 12-month threshold might not deter flippers. He suggested, however, that the government could expand the scope of the rule in the future.

“I do wonder whether this is the thin edge of the wedge,” Moffatt said. “You start out with a system that would apply to almost no one and then over time start to eliminate some of the exemptions, extend the period from 12 months to 24 months to 36 [months], and so on. I think that’s a real possibility here.”

Minicucci agreed the government could adjust the proposed rule if it isn’t successful. However, he believes rising interest rates could curb speculation even before the proposed rule becomes effective.

“The main goal was to try to calm the market with respect to the constant increases in house values,” said Minicucci, speaking in late April. “After the past few weeks, that probably occurred anyway.”