ON THE HUNT

Get ready condo flippers, Canada Revenue Agency is hunting you
By Garry Marr
Financial Post April 20, 2013

You just sold your condo, you made a hefty profit and know you have to pay your taxes.

The bill might be more than you think.

If it’s your principal residence, there’s no tax, as long as you have the paperwork to prove it. The Canada Revenue Agency is taking a closer look at the condominium sector in what some in the industry have dubbed the “Condo Project.”

Even if you own up to it being an investment property, you may not be allowed the capital gains tax break and that means a bigger hunk of your profit going to Ottawa.

Let’s say your gain is $100,000 and your tax bracket is 46%. Capital gains are taxed at 50% so you would only owe $23,000 on that profit.

Not so fast! If the CRA says you are in the business of flipping condominiums, get ready to pay based on the gain being counted as income for a tax bill of twice the amount at $46,000. And, it gets worse. You could also face a fine of up to 50% of the tax owed for making a false disclosure.

With the deadline for filing taxes coming up April 30, you might want to think very carefully about how you record that housing sale you made in 2012.

Sam Papadopoulous, senior public affairs advisor-manager with CRA’s Ontario region, acknowledges that the strength of the condo sector has attracted the attention of the taxman.

“We do from time to time target some sectors more closely than others,” he said. “We look at the real estate market in general. Of course, [there is more focus], it’s a hot market.”

People in the industry have a different view.

Some suggest it fits in with the recent budget when Jim Flaherty, the finance minister, announced his government was taking a closer look at loopholes and tax cheats — hoping to shrink its deficit in the process.

One of the issues attracting the attention of the CRA is assignment clauses, where one person agrees to purchase a condo before it is built but ultimately sells his or her right to buy that condo before the building is even registered.

Builders usually collect a fee for that privilege but ultimately when title is registered at the land registry office the original purchaser’s name is nowhere to be found.

While most builders are unlikely to voluntarily supply a list of properties in their building that were assigned, they could be forced to cough it up if they are audited by the CRA.

Those people who have assigned their units to another buyer are going to be hard pressed to prove they planned to use the unit as an investment property rather just flipping — meaning the CRA is highly unlikely to allow them to count money made at the lower capital gains rate.

“If you keep [assigning property] then it is not capital gains, that’s trade and that’s income,” said Mr. Papadopoulous, adding you do it a “couple of times” and it’s income. “Of course, that’s part of [what they are investigating].”

The warning to people flipping property and thinking they can get away without reporting the gain is pretty clear.

“We live in the information technology age,” said Mr. Papadopoulous, who wouldn’t get into how CRA is tracking down the tax evaders. “We are putting our resources to work and following the trail where we can.”

Robert Kepes, a Toronto tax lawyer at Morris Kepes Winters, said he’s seen the CRA go after people who have been living in a property and still question it as a principal residence.


CRA starts with a letter to a taxpayer asking them for details about when and why they sold their property and people often fill out the questionnaire without legal advice.

The issue goes all the way back to 1971 when there was no tax at all on capital gains so everybody tried to avoid counting gains as income.

Mr. Kepes says the distinction between income and capital is as simple as the difference between a tree and the fruit that it bears.

“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 your condo is that tree and your rental income is the fruit and you make a profit from that rental income, that’s taxed as full income. You eventually sell the tree for more money and that’s just a capital gain, taxed at the 50% rate.

If your entire businesses is just trading trees and not producing fruit, that’s business income.

“The Income Tax Act asks what was your intention when you bought that condo,” said Mr. Kepes. “These principles are easy to describe but harder to prove in fact.”

The law is like a civil case, a judge doesn’t have to believe you beyond a reasonable doubt, but a judge does have to conclude you are more believable than the CRA.

“We have to bring all kinds of intrinsic evidence,” says Mr. Kepes, noting some clients will produce something as simple as a change in address on their driver’s licence to show they were using their condo as a principal residence.

If you never actually moved into the condo, it’s going to be tough to prove that it was principal residence.

You may never have produced income from the profit but that’s not to say you didn’t plan to, so perhaps you could get the capital gains exemption.

“The question can be ‘how did they come to sell the property,’” said Mr. Kepes, adding the CRA might look at whether you were advertising the property for sale.

Brian Johnston, chief operating officer of Mattamy Corp., says the CRA has ways to get information on sales.

“They audit real estate companies, look at the name on the contract and look at the final deed and see a difference,” said Mr. Johnston. “They see Bill Smith bought it and Joe Blow is on the deed. They want to know how this happened and follow the paper trail.”

He has some sympathy for consumers confused about the whole process.

“I think the government should make it a little simpler in terms of filing for principle residence exemption,” said Mr. Johnston. “It’s a real gray area of the 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.”

Condominium developer Brad Lamb, who has been audited several times, said ultimately it’s better to be more conservative when you’re filing — meaning just count the gain as income if you are in doubt.

“If you are prolific buyer or seller of properties, whether it’s condos or not, you have to govern yourself accordingly. If you don’t, you’ll get caught and be fined,” said Mr. Lamb. “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.”

http://business.financialpost.com/2013/04/20/get-ready-to-pay-income-tax-on-your-condo-profit/

BECAUSE KNOWLEDGE IS POWER

How to avoid home buyers’ regret
By: Julian Beltrame
Canadian Press, Aug 16, 2012

With Canadians entering the housing market in greater numbers than ever before, it wouldn’t be surprising to find that many suffer buyers’ regrets.

A recent survey commissioned by TD Canada Trust found the two biggest regrets — reported by 60 per cent of the 1,002 respondents — have to do with finances; not making a bigger down payment and not doing enough research into the costs of home ownership.

That’s not surprising, says Farhaneh Haque, director of mortgage advice with TD.

Even though buying a home is the biggest investment the vast majority of Canadians will ever make, many first time buyers still don’t do the necessary homework.

“It’s not the sticker price that shocks first-time home buyers. It’s the costs associated with the sticker,” she explains.

“We see so many home buyers that after the fact feel they could have used information, that they could have had more preparation going into home ownership.”

For instance, 29 per cent of those surveyed said they didn’t budget for ongoing costs, such as maintenance and utilities. One in eight said they overlooked some of the one-time fees associated with buying, such as inspection and legal fees, title insurance, and land transfer taxes, depending on the home price.

These are not minor omissions.

Paying the mortgage is just the most obvious cost of ownership, and not necessarily the biggest in today’s world of super-low interest rates. The combined cost for municipal taxes, fire and theft insurance, utilities, plus regular upkeep, could actually pinch household monthly budgets more.

“If you are renting, you pay that one shelter cost and that’s all you have to think about. But as a homeowner, there’s more,” says Haque, who tells clients to budget at least $500-$700 on average in additional monthly expenses.

Her advice to prospective buyers is get advice, which is easily available to them. Most first-timers know existing homeowners who have acquired wisdom through experience.

And financial institutions, real estate agencies and other market players regularly stage seminars with experts that can offer sage counsel.

Michele Rowe, a sales representative with Keller Willams VIP Realty in Ottawa, tries to arrange one seminar every month, and she typically invites an inspector and a mortgage broker for their input.

She tells attendees the first thing they should do is to get a buyer’s agent to steer them through the process.

“Most first-time buyers don’t know where to start and don’t know the importance of using their buyer agent,” she says.

The other key advice she gives them is that they need to get pre-approval for a mortgage, so buyers know how much they can spend on a home.

“They need to know how much of house they can afford, based on their income, their GDS (gross debt service) and TDS (total debt) ratios, because they might think they can afford $300,000 when they can’t,” she explained.

The ratios calculate monthly home costs, and other debt charges, as a percentage of household income to determine affordability. A ratio of 40 per cent on all commitments (TDS) is usually acceptable to mortgage lenders.

The survey, which was conducted in the spring, found that 54 per cent of first-time buyers want a single, detached home, but Rowe says that is often impractical. That’s because although interest rates may be low, house prices have been rising steadily — the average resale home in Canada now costs close to $370,000.

In Ottawa, most first-time buyers Rowe sees can only qualify for a home of about $250,000. That price range will most likely mean a condo or townhouse, she said.

Which comes to another key finding in the TD Canada Trust survey — Canadians don’t start saving up for a home soon enough.

Haque said it’s critical for Canadians thinking they will want to own a home one day to get informed about what is involved and how much money they will need. The bigger the down payment, the more flexible a household’s ongoing finances will be.

“A bigger down payment reduces monthly payments, but it also gives owner options for a mortgage that is more flexible,” she explains. “For instance, with more than 20 per cent down payment, an owner can obtain a mortgage with a 30 year amortization period, rather than 25 years, which further reduces monthly payment.”

Photo By: Alexandredrachmann

TAX TIME SHOULD MEAN MONEY IN YOUR POCKET

How your mortgage can lower your tax bill
You can deduct mortgage interest without getting in trouble with the taxman
James Pasternak, Financial Post
Published: Monday, February 22, 2010

When Toronto resident Celia Bernath files her annual income tax return, she includes a long list of deductions from her home-office income. After all, as a chartered accountant, she knows that travel, bank, postage, courier, utility and other charges and expenses are fair game for the micro-entrepreneur. But the item that sometimes has the most impact is deducting a proportion of her residential mortgage interest.

"The mortgage-interest deduction - like other deductions - is based on the square footage of my office divided by the total square footage of the house. Keeping track of all your household expenses is very important," says Ms. Bernath, who has about 15 corporate and 100 personal clients.

Ms. Bernath is one of the more than 700,000 home-based business owners who might be eligible to deduct a portion of their mortgage interest on their principal residence as an expense.

Generally speaking, in Canada, interest on residential mortgages is not tax deductible.

However, Ms. Bernath can do so because there is a direct link between the borrowed money and earning income.

"The long and short of it is if you want to be able to deduct interest on your mortgage, the loan has to be incurred for business purposes," says Yens Pederson, a partner with the Regina law firm of Balfour Moss LLP.

Canadians like to talk about mortgage-interest deductibility because the mortgage on a principal residence is the biggest debt Canadians have. They also like to talk about it because tax laws in the United States have provisions for residential mortgage-interest deductibility. Far fewer realize that Americans must pay a capital gains tax when they sell their home.

But beyond the fairly straightforward deductions of mortgage interest, the political machinations and bookkeeping shenanigans have made the mortgage-interest debate a colourful one in Canada.

Many say that the promise of mortgage-interest deductibility put the Conservatives in power and made Joe Clark prime minister in 1979. The Clark government was gone within nine months and the legislation was never enacted.

In 2003, the Conservative Party of Ontario announced that if re-elected it would pass legislation allowing homeowners to deduct $5,000 of their mortgage-interest payments from their taxable income, resulting in up to $500 in savings for homeowners. The party was defeated in the next provincial election.

Between these political attempts to liberalize mortgage-interest deductibility, the federal government moved to restrict tax avoidance strategies. In 1988, Parliament enacted the general anti-avoidance rule (GARR) to curb so-called "abusive" tax avoidance.

Under its most common allowances and interpretations, mortgage-interest deductions can still work as an effective strategy for reducing taxes. In addition to the case of a home business, one can deduct mortgage interest when investing in a residential rental property.

"If you are purchasing a property and you take a mortgage to purchase that property and then you rent out that property, then you are getting rental income from it," said Todd Trowbridge, a partner of Toronto-based accounting firm Trowbridge Professional Corp. "That interest would be deductible. There always has to be an earning income use of the funds."

Take the case of Toronto resident Howard Frank who invested just more than $400,000 in a 2,400-square-foot residential rental building with three units in May 2007. Mr. Frank took out a $300,000 mortgage, paying 5% interest. So in addition to a wide range of other deductible expenses such as property tax, maintenance, any utilities, insurance, administrative and legal fees, Mr. Frank deducts $15,000 in interest payments against the $33,600 in rental income.

A similar mortgage-interest deduction opportunity exists when one is renting out a room in one's principal residence or is earning income from a vacation property for all or part of the year. In both cases, the arrangement must be a legitimate commercial agreement.

"If you rented [the vacation property] out below value to family it would probably be offside. If you rented it out to third parties at a reasonable rate [the Canadian Revenue Agency might] look to see whether there was any commercial reality. At the very least you could deduct it off the rental income for the portion of time it was actually rented," says Mr. Trowbridge.

Some deduct mortgage interest through "the Smith manoeuvre" as promoted by Victoria, B.C.-based former financial strategist Fraser Smith. In its simplest terms, the homeowner pays down the mortgage as quickly as possible, creating small amounts of equity each month.

The equity is simultaneously filled with a line of credit to be used for investment purposes. The interest on the growing investment loan is deductible.

"Instead of giving it to the bank for making mortgage payments we can then invest it in ourselves and build our investment portfolio," says Mr. Smith, 71, who has sold 53,000 copies of his book Is Your Mortgage Tax Deductible?

"You deduct the interest on the investment loan. In the end, if you started with a $300,000 mortgage, you will end up with a $300,000 investment loan. So you'll be deducting the interest on the $300,000 for the rest of your life."

One way to deduct mortgage interest without actually paying the interest is through a reverse mortgage. The reverse mortgage allows a homeowner to tap into the equity of his or her home without having to pay interest or principal on the loan. The loan is satisfied on the death of the home owner or the selling of the home. Therefore, when the proceeds are invested, the homeowner can deduct interest charges against investment income, without actually paying the interest.

"CHIP Home Income Plan interest expenses may be used as a deduction to offset, in part or entirely, income tax liability generated by investments - as long as those investments were purchased with CHIP proceeds," says Arthur Krzycki, director or marketing and public relations at reverse mortgage specialist HomEquity Bank.

Mr. Krzycki says that if one invests a $100,000 reverse mortgage at current rates, the interest expense will be about $3,750. If one has an investment that earns a 3.75% return in the same time period, the two amounts will offset. So, the 3.75% investment income appears to be "tax free" for cashflow purposes, while the interest expense is added to the outstanding balance of the reverse mortgage.

An even more creative application of mortgage-interest deductibility came in the late 1980s. John Singleton, a partner in a law firm, tested current mortgage-interest deductibility rules by withdrawing $300,000 from his partnership capital account to purchase a house. Mr. Singleton then mortgaged the house by borrowing $298,750 from the bank and depositing the money into his partnership account, along with $1,250 of his own money.

When the time came to do his tax return, Mr. Singleton deducted $3,688 of interest on his 1988 tax return and $27,415 on his 1989 return. Mr. Singleton argued the borrowed funds, not the withdrawn funds, were used for investment purposes.

The deduction was originally challenged by Revenue Canada, as the taxman was then called, and after the case wound its way through the courts Mr. Singleton finally won the day.

"The court effectively looks at the direct use - the form of the transaction - and does not consider economic substance," says Daniel Sandler of Toronto-based law firm Couzin Taylor LLP. "So, by the same token, if a taxpayer cannot demonstrate that the direct use of the borrowed money was an income-earning purpose, the interest will not likely be deductible."

By January 2009, the Supreme Court of Canada sent a signal that it was open to creative applications of mortgage-interest deductibility, but not financial shenanigans. The case in question dates back to 1994, when the Lipsons, a husband-and-wife team, entered into an agreement to buy a home. Ms. Lipson borrowed $562,500 from a bank to buy shares from Mr. Lipson in a family investment company. The couple then obtained a mortgage from a bank for $562,500, using the funds to repay the share loan in full. In his 1994, 1995 and 1996 tax returns, Mr. Lipson deducted the interest on the mortgage loan and reported the taxable dividends on the shares as income where it was applicable.

"In essence, the majority of the court allowed the interest expense, but in the hands of Mrs. Lipson not Mr. Lipson. According to the majority, the interest-expense rule was not the rule that was abused in the case; it was the attribution rule," says Mr. Sandler.

Recently, a more liberal interpretation of mortgage-interest deductibility has emerged. In November, 2009, the Tax Court of Canada ruled in the case Henkels vs. The Queen, that expenses deducted from rental income in a private residence do not have to be directly tied to the square footage used by the tenant. The Henkels rented 700 square feet of space to a tenant, which is only 35% of the square footage of their home, but deducted 50% of the acceptable household expenses because the tenant had access to the entire house.

"This case reinforces the position that you could measure expense deductibility on a reasonable basis other than square footage," says Marc Weisman, a tax lawyer at the Toronto-based firm of Torkin Manes LLP.

As for Mrs. Bernath, she takes the more cautious approach, sticking with existing standards. "[The ruling] does allow you the opportunity to deduct more," she says. "It is good to be aggressive but being too aggressive gets you a nasty invitation from CRA."

"Yes," says Mrs. Bernath, "walk on the grey line [but] ensure that your expenses can be justified."

FYI - BUYER BEWARE - CRA

Please release me
Withholding tax: Non-residents selling their Canadian home be warned
Helen Morris, National Post
Published: Saturday, February 20, 2010
Moving house can be pretty stressful, when you have to line up all the finances, paperwork, packing up, getting a moving truck and so on. However, if it is a move out of the country, there are still more things to consider.

In a standard Agreement of Purchase and Sale, a person selling their home in Canada must be able to declare that, for the purposes of Canadian taxation, they are a resident of Canada. If he cannot, he must provide the purchaser with a certificate of compliance from the Canada Revenue Agency (CRA). While most of us think that proceeds from the sale of a principle residence are not taxed, that doesn't hold for non-residents. Profit from the sale of a property may be subject to capital gains tax unless an exemption is obtained from the CRA.

(To determine whether you are a non-resident for income tax purposes, visit the CRA's website at cra-arc.gc.ca/tx/nnrsdnts/ndvdls/nnrs-eng.html.)"When a non-resident taxpayer sells taxable Canadian property -- which includes real estate-- they are required to file for a 116 Tax Certificate (Form T2062) with CRA within 10 days of the sale," says Tannis Dawson, a tax and financial planning expert with Investors Group.

The certificate can take two to three months to obtain; in the absence of the certificate, the buyer becomes liable for any tax owed by the non-resident seller.

"If the seller leaves and doesn't pay the tax, the government has decided it has the right to collect against the buyer," says Ray Leclair, real estate lawyer and vice-president at TitlePLUS. "So, to protect the buyer, it put in a provision that says if the seller is a non-resident, the buyer has the right to withhold up to 25% of the purchase price" until the seller produces a certificate of compliance from the CRA. That withheld amount is put in a trust account by the buyer's solicitor.

Caroline Blake, a British citizen who was a Canadian resident, moved to a new job in the U.K. and then sold her Toronto home. She says her solicitor first told her about the need to obtain this tax certificate a couple of weeks before closing. At the time the deal closed, the buyer of her Toronto property had the right to withhold 25% of the purchase price until Ms. Blake was able to provide the certificate. However, Ms. Blake's solicitor had assured her that even with the 25% withholding tax, there was enough equity in the home to cover closing costs and pay off the mortgage. Ms. Blake returned to Canada last month to finalize the sale of her home.

"The night before I flew back, the solicitor sent me an email, effectively saying, 'Whoops, sorry, I made a mistake. There isn't enough equity in the house. Could you please come with a $32,000 cheque,'" says Ms. Blake. "I sent her a very curt note saying, 'We've left the country --it's not as if we have a spare $32,000 in our Canadian bank accounts, so you'd better come up with an alternative.'"

Because Ms. Blake sold her home after she had left Canada, she was not allowed to sign the declaration saying she was a resident for tax purposes. But because she sold her house at a loss, she will not have any capital gains to be taxed. In order to close the sale, her real estate agent and the buyer's agent agreed to wait for their commissions until the compliance certificate is obtained and the 25% withholding tax is released. Advisors say this situation could have been avoided.

"They could have got this certificate before they started marketing, as soon as they knew they were selling the property," says Mr. Leclair. This would then have been given to the buyer so they would not be on the hook for any unpaid tax.

Ms. Dawson says the CRA will issue a certificate before a sale actually occurs, using the price you expect to get for the property. If there is tax payable, the seller pays the tax or provides security to the CRA that the tax will be paid ( just what this security could consist of, the CRA says "you or your representative should contact the Revenue Collections Division of the applicable Tax Services Office.")

The seller must file a tax return for the year the sale of the home took place. Any overpayment of the tax can be refunded. Other costs such as real estate fees, legal fees, and any other closing costs could be set off on your general taxes against any gain to reduce the tax you may have to pay.

For further details on selling property as a non-resident, including exemptions for a principal residence, see Canada Revenue Agency details at cra-arc.gc.ca/E/pub/tp/ic72-17r5/ic72-17r5-e. html

Photo By: Squirlaraptor