TaxMatters@EY: Family Wealth Edition – February 2023

Gael Melville, Vancouver, and Dean Radomsky, Calgary

Housing topics continue to make the headlines in Canada, whether it’s due to rising interest rates or concerns about housing affordability. In its last two budgets, the federal government has made changes to tax policy aimed at tackling affordability, and several new measures are either already in place or soon to take effect. This article provides an update on recent developments in three areas: the new residential property flipping rule, the underused housing tax and the tax-free first home savings account.

Residential property flipping rule¹

If you acquire a residential property and resell it at a profit in a relatively short period of time, the profit (i.e., gain) on the resale may be treated as business income rather than as a capital gain. This means that the gain is fully taxable, as neither the 50% capital gains inclusion rate nor the principal residence exemption will apply.

The government became concerned that certain individuals engaged in flipping residential real estate were incorrectly reporting their profits as capital gains and, in some cases, claiming the principal residence exemption.² The 2022 federal budget introduced new residential property flipping rules to ensure that profits from flipping residential real estate located in Canada are excluded from capital gains treatment, and are instead subject to full taxation, by recharacterizing the capital gain as business income.

If a flipped property is sold at a loss, the new rules deem the loss to be nil for income tax purposes so it cannot be deducted against income.

These new rules apply to dispositions of flipped property that occur after December 31, 2022.

What is a flipped property?

For purposes of these rules, a flipped property means a housing unit³ — other than a property that is inventory of the individual — located in Canada that was owned for less than 365 consecutive days prior to its disposition, unless the disposition occurred as the result of one or more life events (listed below).

An individual who disposes of a flipped property in 2023 or later is deemed to be carrying on a business that is an adventure or concern in the nature of trade — the flipped property is deemed to be inventory of that deemed business and not a capital property. As a result, any gain on the disposition is fully taxed as business income and the individual cannot claim capital gains treatment or the principal residence exemption.

As indicated above, even though a flipped property is deemed to be inventory of a business carried on by the individual, any loss incurred on the disposition of the flipped property is denied (i.e., deemed to be nil). The loss denial rule appears intended to ensure that a capital gain on a flipped property is not converted into a business loss after the deduction of any expenses allowed in computing business income, such as mortgage interest, but that are not deductible in computing a capital gain.

This loss denial rule does not apply if the property is otherwise treated as inventory of a business carried on by the individual due to the exclusion from the meaning of flipped property. Therefore, individuals in the business of flipping property who record all gains and losses on income account should not be subject to this rule.

Exclusions for life events or circumstances

The property flipping rules recognize that there are some situations where holding a residential property for less than a year does not indicate an intention to profit.

The deeming rules do not apply if it is reasonable to consider that the disposition of the property occurred due to — or in anticipation of — one or more of the following life events:

• Death of the individual or a related person
• One or more related persons becoming a member of the individual’s household (e.g., birth of a child or care of an elderly parent), or the individual becoming a member of a related person’s household
• Separation where the individual and their spouse or common-law partner have been living separate and apart because of a breakdown in their relationship for at least 90 days prior to the disposition
• Personal safety concerns (e.g., threat of domestic violence) with respect to the individual or a related person
• The individual or a related person suffers a serious disability or illness
• An eligible relocation of the individual or their spouse or common-law partner (in the case of a new work location, the new residence must be at least 40 km closer to the new work location, and there is no requirement for the new residence and new work location to be in Canada)⁴
• Involuntary termination of the individual’s or their spouse or common-law partner’s employment
• Individual’s insolvency
• Destruction or expropriation of the property

Even if the new deeming rules do not apply because of one of the exceptions listed above or because the property was owned consecutively for 365 days or more, a profit from the disposition of property could still be taxed as business income. In each case, it will be a question of fact whether the profits are treated as a capital gain or as business income. The determination is made by reference to a number of factors, including the number of similar transactions and the circumstances surrounding the sale.

Assignment sales⁵

The government announced in November 2022 that it would expand the new residential property flipping rule to cover profits from assignment sales, applicable to transactions occurring on or after January 1, 2023.⁶

Under this proposal, if you dispose of a right to purchase residential property and the right was held for less than 365 days before disposition, the profit would be treated as business income and would not be eligible for capital gains treatment, subject to the exceptions for certain life events or circumstances described above.

If you hold a right to purchase a residential property under a purchase and sale agreement and proceed with the purchase, the 12-month holding period resets on the date of the property purchase. The property flipping rule may then apply if you dispose of the residential property itself within 12 months of its acquisition.

Underused housing tax

Canada’s new underused housing tax became law on June 9, 2022 as part of Bill C-8, Economic and Fiscal Update Implementation Act, 2021. In general terms, the underused housing tax is an annual 1% tax on the value of vacant or underused residential property that is directly or indirectly owned by nonresident non-Canadians — individuals who are neither Canadian citizens nor permanent residents of Canada — effective as of January 1 2022.

Even if you don’t have to pay the tax for a particular year, you may still have to file a return and penalties apply for late-filed returns.

Annual filing requirement: first deadline approaching

The stated purpose of the Underused Housing Tax Act (UHTA) is to make sure that nonresident owners who are using Canada as a place to passively store their wealth in housing pay their fair share of taxes. However, the legislation implements a broad annual tax filing requirement that may apply even if the owner of the property is exempt from the annual tax.⁷ An owner of one or more residential properties on December 31 of a calendar year is required to file a return for each residential property, unless they are an excluded owner.

Excluded owners include Canadian citizens and permanent residents of Canada, certain publicly listed entities, and registered charities. They are not subject to the tax or the annual filing requirement.

However, Canadian trusts, partnerships and privately owned corporations are not excluded owners. Therefore, for example, if a bare trustee owns a residential property on behalf of a Canadian citizen or resident, the bare trust will qualify as a specified Canadian trust under the UHTA and the bare trustee will be exempt from the annual underused housing tax. However, the trust will be required to file an annual return in respect of the property.⁸

An owner who is required to file a return for a calendar year must do so on or before April 30 of the following calendar year. As a result, if you have to file a return for the 2022 calendar year, you must file it on or before April 30 2023.

Failure to file a return as and when required may result in a penalty of at least $5,000,⁹ and a loss of exemption status if the return is not filed by December 31 of the following calendar year.

At the time of writing, the CRA has not yet released a copy of the new return form. However, under the Underused Housing Tax Regulations, the CRA can require an individual to provide their social insurance number on a UHTA return.

Recent developments

Under changes made to the Income Tax Act in December 2022, the CRA may decline to issue a section 116 certificate in respect of a proposed or actual disposition of real property in Canada by a nonresident if the nonresident failed to comply with any requirement to pay tax, or failed to file a return under the UHTA in respect of the property.¹⁰

In addition, regulations have now been passed to formalize the vacation or recreational property exemption that was first announced on December 14, 2021. Under this exemption, no underused housing tax (UHT) is payable for a property for a year if the property is:

• Located in an area of Canada that is not an urban area within either a census metropolitan area or a census agglomeration having 30,000 or more residents¹¹
• Used personally by the owner — or the owner’s spouse or common-law partner — for at least 28 days in the calendar year

Note that even if no UHT is payable because the property itself qualifies for an exemption as a vacation or recreational property, the owner may still be required to file a UHTA return for the year.

It’s important to familiarize yourself with the rules to ensure you are not caught off guard for the first annual reporting deadline of April 30, 2023. For your reference, EY Tax Alert 2022 Issue No. 35, Canada’s new Underused Housing Tax Act receives Royal Assent provides a detailed discussion on the framework and application of the new tax, including who is considered an owner and an excluded owner for purposes of the tax, and who is eligible for one of the many exemptions from the annual tax.

Tax-free first home savings account update

In the October issue of TaxMatters@EY, we discussed the new tax-free first home savings account (FHSA) that is expected to be offered in 2023.

The FHSA is a new type of registered account intended to help Canadians save for a down payment for their first home. The Department of Finance first released a draft version of the proposed FHSA rules in August 2022. In November 2022, the Department of Finance released an updated version of the FHSA proposals, which included several changes from the original proposals and became law in December 2022.

The main changes from the August 2022 proposals were:

• The FHSA rules will take effect on April 1 2023, instead of on January 1 2023, as originally proposed.
• There is now no limitation on using both the FHSA and the Home Buyers’ Plan for the same qualifying purchase of a home.¹² Under the previous version of the rules, an individual had to choose to use one or the other of these programs.
• For an individual to make a qualifying FHSA withdrawal (i.e., one that is tax free), the individual must be resident in Canada throughout the period from the time of the withdrawal until the time when the home is acquired, or the time of the individual’s death if this occurs earlier. Under the previous version of the rules, the individual only had to be resident in Canada at the time of the withdrawal.
• An individual will not be considered a first-time home buyer if at any time in the calendar year before opening an FHSA, or in the preceding four calendar years, they inhabited as their principal residence a qualifying home that either they or their spouse or common-law partner owned. Under the previous version of the rules, only homes that the individual owned or had an interest in were taken into account in determining their status as a first-time home buyer.

For a general overview of the FHSA framework prior to the Bill C‑32 amendments, refer to the October issue of TaxMatters@EY, What’s new for first-time home buyers?.

Conclusion

If you’re a homeowner or prospective home buyer, you need to be aware of the latest developments with respect to the tax rules surrounding housing transactions. The new FHSA could make it easier for you to buy your first home, while the residential property flipping rule could cause an unwelcome surprise if you sell a property after only a short period of ownership.

Talk to your EY advisor for more information on how these measures may apply to your situation.

Lucie Champagne, Alan Roth, Candra Anttila and Yiyun Chen, Toronto

Frequently referred to by financial planning columnists, our mobile-friendly 2023 Personal tax calculator lets you compare the combined federal and provincial 2023 personal income tax bill in each province and territory. A second calculator allows you to compare the 2022 combined federal and provincial personal income tax bill.

You’ll also find our helpful 2023 and comparative 2022 personal income tax planning tools:

• An RRSP savings calculator showing the tax saving from your contribution
• Personal tax rates and credits by province and territory for all income levels

In addition, our site offers you valuable 2023 and comparative 2022 corporate income tax planning tools:

• Combined federal-provincial corporate income tax rates for small business rate income, manufacturing and processing income, and general rate income
• Provincial corporate income tax rates for small business rate income, manufacturing and processing income, and general rate income
• Corporate income tax rates for investment income earned by Canadian-controlled private corporations and other corporations

You’ll find these useful resources and several others — including our latest perspectives, thought leadership, Tax Alerts, up-to-date 2023 budget information, our monthly TaxMatters@EY and much more — at https://www.ey.com/en_ca/tax.

Tax Alerts – Canada

Tax Alert 2022 No. 45 – Bill C-32 to implement certain Budget 2022 and other previously announced measures receives Royal Assent

Tax Alert 2023 No. 1 – CRA announces changes to its administrative policies for certain taxable benefits

Tax Alert 2023 No. 2 – Trade compliance verification list update: January 2023