August 24, 2020
If you renovate and sell your home, how much tax do you pay? Does it count as a primary residence? Will you pay capital gains? How much is capital gains tax? Is real estate income considered business income? We can help.
Is House Flipping Considered Capital Gains or Business Income?
Wondering about the difference between capital gains tax and business tax? Which will you be charged when you sell your property? We can help.
What Tax Do You Pay When You Flip a House?
Flipping a house (buying a home, renovating it, and reselling it) can make you quite a lot of money, with the right renovations and in the right real estate market. However, unless a property is considered your primary residence, you’ll have to pay tax on this money, which can seriously cut into your profits. Plus, if you wind up having to pay CRA capital gains and you did not expect to do so, you may not have the money you need to afford the taxes, which can be a serious problem.
You are exempt from paying taxes on the sale of a property if it is your primary residence. For a property to be considered a primary residence, you or your family must have “ordinarily inhabited” the property. You may designate one property per year as your primary residence and there is no specific amount of time that you must live in the home for it to be considered “ordinarily inhabited.”
Up until recently, you did not have to report the sale of a primary residence on your income taxes. However, starting with the 2016 tax year, you are required to list the details of the sale, even if the property is fully protected by the primary residence exemption.
On all other properties, you must pay taxes on the profits of a sale. What does this mean for “house flippers” and how much tax would you pay if you flipped a home? That depends on several factors.
Designating a Property your Primary Residence
As mentioned, Canadians are exempt from paying capital gains tax on the sale of a primary residence. This means that some people may try to claim the home that they flipped as their primary residence during the renovation period, so that they would be exempt from taxes. However, the CRA is aware of this tactic and takes steps to prevent people from using it. The CRA capital gains exemption only applies to the sale of your primary residence and the CRA abides by this strictly.
There is no specific amount of time that you must live in a home in order for it to be considered “ordinarily inhabited.” When you list the sale of the property on your taxes, the CRA will take several factors into account when deciding whether a property should rightfully be considered a primary residence. This includes the intent at the time of purchase, the timeframe between the purchase and sale, the number of purchases and sales that a person has made, the number of primary residence designations a person has made, etc.
This means that, if you flip a home, the CRA will likely find out and you will be charged taxes. If you fail to report your profits accurately and the CRA finds out about it, you could be charged penalties and interest on the tax owing.
Whether you are charged capital gains tax on Canadian real estate or business income could significantly affect your tax situation, so you want to be sure that you report everything accurately. Otherwise, you may be hit with an unexpected tax bill.
Capital Gains versus Business Income
In most cases, if you sell a property that is not your primary residence, you will be charged taxes. However, how much you are charged will depend on whether the CRA considers the profits to be business income or capital gains.
How much is capital gains tax? Capitals gains tax is charged at half of the rate as ordinary income. How to calculate capital gains tax? You don’t need a capital gains tax calculator to figure it out. You take half of the amount of the profit and this is the amount you will pay tax on. For example, if you sell a property and make a profit of $50,000, you will pay capital gains taxes on half of that amount ($25,000) at your marginal tax rate.
However, depending on your circumstances, the CRA could consider your real estate profits to be business income. If this is the case, you will need to pay taxes on the full amount ($50,000). This difference is obviously very important. As you can see, the capital gains tax rate is half of what you would pay in business taxes.
How does the CRA determine whether the money made from selling a property is business income or not? Again, there are many factors. If the CRA believes that you purchased the property with the intent of selling it for a profit, it will likely consider it as business income. Much like how the CRA determines whether or not a property is your primary residence, the agency will look at how many properties you’ve bought and sold, how often you’ve done this, the nature of the renovations, the timeframe of the purchase and sale, and many other factors. However, if you generated money from the property while you owned it (such as if you rented it out and made money from rent) then it will likely be considered a capital gain instead.
The CRA will also look at your profession when determining whether it considers the profits of a sale to be business income. If you are a builder, contractor, or have a similar profession, it’s more likely that the CRA will consider your profits as business income and charge you as such.
As you can see, this situation can get complicated.
If you are in a situation where the CRA is claiming that you misrepresented your income or if it has told you that you owe more money in taxes than you expected, due to the CRA classifying the sale of a property differently than you did, you can dispute these charges. Having to pay CRA capital gains tax or business income taxes when you did not expect to do so can be a tough financial pill to swallow, and you may not be able to afford these taxes. That’s why it’s important that you resolve your tax situation as soon as possible.
However, the CRA is very tough to deal with, so you will want to speak to a professional first. Please contact us today to see how we can help.