Kapadia LLP CPAs

One of the most valuable tax and investment strategies available to Canadians is home ownership. While the real estate market can (and does) go and up down, home ownership has proven to be, over the long term, a reliable way of building net worth.

The value of home ownership as a wealth-building tool is significantly increased by the tax rules which apply when a homeowner sells his or her home. Essentially, where an owner-occupied home is sold, the gain realized on that home which would, under ordinary tax rules, be included in income is instead received tax-free.

For example, a homeowner who purchased his or her home in 2000 for $200,000 and sells it in 2022 for $800,000 will earn a gain of $600,000. Half of that amount, or $300,000 would, under ordinary tax rules, constitute a taxable capital gain, on which the amount of combined federal-provincial tax could be close to $150,000. However, because of a tax rule known as the principal residence exemption, the entire gain realized is not included in income, and no tax is payable on that $600,000 amount.

It's not hard to see that being able to claim the principal residence exemption on the sale of a residential property is a huge benefit – so much so that the federal government has become concerned that individuals who are “flipping” residential real estate are claiming tax benefits to which they are not entitled on the income earned from such sales, including making claims for the principal residence exemption.

The federal government has chosen to address this situation with a change which was announced in the 2022 federal Budget and which will take effect for residential property sales which take place on or after January 1, 2023. The proposed new “deeming” rule will provide that, where an individual sells a residential property within 365 days of acquiring it, that property will be considered a “flipped property” and profits realized will be treated as business income and will be fully taxable, unless the sale takes place in relation to one or more enumerated “life events” or circumstances. In effect, the rule seems to place the onus on the taxpayer who sells a residential property within one year after purchase to show that his or her reasons for selling within one year of purchase either fall under one of the exempted “life event” circumstances or, if not, that the facts are such that he or she is nonetheless entitled to claim the principal residence exemption on any gain realized from the sale.

The new rule will not apply where a taxpayer sells a property within 365 days of acquiring it, and the sale of that property can reasonably be considered to have occurred due to, or in anticipation of, one or more of the following events:

• Death: the death of the taxpayer or a related person.

• Household addition: one or more persons related to the taxpayer joining the taxpayer’s household or the taxpayer joining the household of a related person’s household (e.g., birth of a child, adoption, care of an elderly parent).

• Separation: the breakdown of a marriage or common-law partnership, where the taxpayer has been living separate and apart from their spouse or common-law partner for a period of at least 90 days prior to the disposition.

• Personal safety: a threat to the personal safety of the taxpayer or a related person, such as the threat of domestic violence.

• Disability or illness: the taxpayer or a related person suffering from a serious disability or illness.

• Employment change: a change in employment for the taxpayer or their spouse or common-law partner.

• Involuntary termination: the employment of the taxpayer or their spouse or common-law partner is terminated by their employer;

• Insolvency: insolvency of the taxpayer.

• Involuntary disposition: the expropriation or the destruction of the taxpayer’s property.

The list of taxpayer circumstances in which the new rule will not apply to a sale within one year is undeniably broad; however, many of the criteria used to determine eligibility for an exemption from the new rule are, in some instances, quite subjective. A sale within 365 days of purchase which is the result of “serious disability or illness” would be exempt from the new rule, but it’s not clear what criteria would be applied to determine what constitutes a serious illness or disability, or who would make that determination.

It's clear that the federal government’s target for the new deeming rule is individuals who buy residential properties intending to sell quickly for a profit and not individuals and families who, for any number of reasons, decide to sell within a year of buying their home. However, the net for the new rule has been cast very broadly and it’s unclear how that new rule, as currently drafted, will be efficiently administered in a way which achieves the government’s objectives, without overreach. Fortunately, the federal government will, prior to enacting this new rule four months from now, in January 2023, be carrying out a consultation process in which these or any other issues may be raised. Any interested taxpayer can contribute to that consultation process, which will continue until September 30, 2022. More information on how to participate can be found on the Finance Canada website at Government delivering on Budget 2022 commitments to Canadians - Canada.ca.

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The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.