Principal Residence Exemption and House Flipping
Real Estate Services, Personal Tax, Real Property
Principal Residence Exemption and House Flipping
Principal Residence Exemption and House Flipping: Court Allows Appeal as Taxpayer Relied on Accountant’s Advice
Our Tax lawyer Ruby Grewal summarizes recent Tax Court appeal case regarding Principal Residence Exemption and House Flipping below.
The Tax Court of Canada recently released a decision in Hansen v. The Queen, 2020 TCC 102. This was a case where the taxpayer was reassessed for property that he owned and respectively sold between 2007 and 2012. Mr. Hansen (the “Taxpayer”) sold 5 homes during the respective tax years, and claimed the principal resident exemption. However, the Canada Revenue Agency (the “CRA”) treated the sale of each of these properties as income from a business or from an adventure in trade and reassessed the Taxpayer at 100% of the gain. A typical argument relied on by the CRA is the intention of the taxpayer to purchase the home with an intention to sell them at a profit.
The Taxpayer lived in each of the 5 properties for under a year, and made improvements to each of the homes to suit his family. While filing his taxes, he testified that he informed his accountant of all the property transactions, including his intension for each property and reason for sale, at which time the accountant advised the principal residence exemption applied. The accountant testified at trial and corroborated the Taxpayer’s evidence at trial.
Statue Barred Years
The 2007-2009 reassessments were issued to the Taxpayer outside of the “normal reassessment period” of 3 years as defined by subsection 152(3.1) of the Income Tax Act (the “Act”). This is something that we often refer to as the statute barred years. In order to open up an assessment beyond the normal period of 3 years, the CRA must justify why a reassessment should be reopened or reconsidered. One such reason that the CRA can reopen reassessments beyond the normal period is if the CRA can prove that (1) the Taxpayer had made misrepresentations in his or her tax returns; and (2) this misrepresentation was attributable to neglect, carelessness, willful default or fraud.
In this case, the CRA relied on the argument that the Taxpayer reported the sale of the properties as his principal residence, when they should have been declared as business income.
The Tax Court cited longstanding case law which states that there is no negligent misrepresentation where, at the time of filing the return, the taxpayer carefully considered his or her position and filed on a basis that he or she believed, in good faith, to be correct. This is the case even if the CRA does not agree with the manner in which the taxpayer reported his or her income even if the taxpayer’s position is ultimately found to be incorrect by the Tax Court.
In this decision the Tax Court found that the Taxpayer carefully assessed his situation and filed his returns on a reasonable and honest belief that he was entitled to claim the principal residence exemption. The Taxpayer was honest with his accountant when the sale of the properties occurred, and the court relied heavily on the accountant’s evidence regarding the Taxpayer’s intention at the time of filing.
The Tax Court held that the CRA was not entitled to reassess the Taxpayer for the statute-barred years (2007-2009), and overturned those reassessments.
Is the Transaction an Adventure in the Nature of Trade
The Taxpayer was still assessed for the 2011 and 2012 taxation years. The Tax Court relied on whether the Taxpayer had an intention to make a profit from the transaction by looking at the primary and secondary intention of the Taxpayer at the time of acquiring the properties. Was the intention to live there long term, or was it a temporary move with the intent to resell the properties for profit?
The Tax Court in this case found that the Taxpayer had the primary intention to resell the two properties in 2011 and 2012 as the Taxpayer had already purchased another bare lot and was starting to build on that lot before buying the two properties that were reassessed in 2011 and 2012. While purchasing the two properties, the Taxpayer chose houses that would be easier to resell once his constructed home was complete. As such the principal residence exemption did not apply to these two properties.
Gross Negligence Penalties
The CRA has the ability to impose penalties for the taxation years that have been reassessed under subsection 163(2) of the Act. The Taxpayer in this case was assessed with penalties for making a false statement or omission in filing his income tax returns. Typically penalties range from 5% to 50% of the amount that is being reassessed.
In regards to the gross negligence penalties the Tax Court emphasized that “gross negligence” is a high level of misconduct.
The Tax Court ultimately decided that the 2007-2009 years were statute barred, and as such gross negligence penalties did not apply.
With respect to the 2011-2012 taxation years, the Tax Court considered factors that the CRA must establish to justify the penalties. The CRA must prove that the conduct of the taxpayer was a marked and substantial departure from the conduct of a reasonable person in the same circumstances. The question to be answered is whether the Taxpayer was knowingly or willfully blind in his reporting obligations.
The Tax Court found that the Taxpayer’s conduct was that of a reasonable person, and again found that the Taxpayer’s reliance on his accountant was an important factor. The Tax Court considered the fact that the Taxpayer provided his accountant with all the necessary information prior to the accountant advising him that the principal residence exemption applied.
The Tax Court overturned the gross negligence penalties.
- House flipping has complex tax considerations - you should be aware of the tax consequences as capital and business income are treated very differently.
- When the CRA reassesses statue-barred years and gross negligence penalties, it is prudent to seek legal advice because there are many factors that are considered in upholding the two, absence of which could ultimately result in success for a taxpayer. These issues should be considered in any case.
- Reliance on a professional in filing tax returns can carry significant weight in a case where an individual is selling properties within a relatively short timeframe. A taxpayer should always provide their accountant or other tax advisor with all relevant information regarding a real estate transaction prior to completing tax returns. Also, keep notes when these discussions occur with the advisors, as they may prove to be critical if the situation goes to trial.
Note to our Readers: This is not legal advice. If you are looking for legal advice in relation to a particular matter, please contact our Tax Group.
Ruby Grewal is a corporate and litigation lawyer. Her practice consists of restructuring her client’s business’, assisting clients with their business or personal disputes as a result of an audit or reassessment with the Canada Revenue Agency, foreclosure matters, and builder’s liens. Ruby has acted for a wide range of clients from individuals to businesses and has appeared in front of the Provincial Court, Supreme Court, and the Tax Court of Canada.
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