Advisors have been urged to brush up on their real estate tax knowledge, with the CRA throwing more auditors at the issue.
Mistakes in tax returns appear to have left millions of dollars out there and, with many transactions of this nature of high value, the agency is redoubling its efforts to recoup money.
Mariska Loeppky, director, tax and estate planning for IG Wealth Management, believes investors are often making innocent errors because of the relatively new adminstrative change to reporting your principal residence exemption disposition.
From the 2016 tax year, residents are required to report basic information, like date of acquisition, proceeds of disposition and description of the property, on income tax and benefit returns, when they sell their principal residence residence.
An example, explained Loeppky, could be when someone owns land and a few years later builds a house on it. She added: “You can't claim a principal residence exemption for that property while it’s just land until you live in that home.
“So, when you go and report that disposition, you probably think, ‘that's always been my house or I have always lived in that house’. But really, you owned that property for a few years before you could claim it as your principal residence.
“People don't understand how that calculation works, and how that exemption works. Another example is that people are flipping properties and they've taken the position that they can claim their principal residence exemption.
“But the CRA says, ‘hey, you've actually sold quite a few homes in the last little while so you are in the business of flipping homes’. They would treat that as business income, not a capital gain.”
Some advisors, she added, have been caught out by clients gifting properties at less than the fair market value. You are, in fact, deemed to disposition the property at fair market value rather than gift it to avoid tax or probate fees upon death. Renting is another example and represents a change of use for the property, which should be reported to the CRA.
Loeppky said: “Advisors must make sure they know what the reporting obligations are. If you are in doubt, hire a professional accountant to help you with your tax return. Most of the tax preparers that I see packages from, they’re asking the questions: did you sell your home? Did you start renting it out?
“These could have tax implications. Just knowing that, while the principal residence exemption is there to protect you, you have to report it and there are significant penalties for not doing so. If you forget to disclose that you sold your home on your tax return, it’s a penalty of $100 a month, up to a maximum of $8,000.
“Even though you’ve got a tax free transaction, or what you think is a tax free transaction, not reporting it in theory could land you with an $8,000 penalty, which is pretty steep.”
There is also the issue of foreign property, with Canadians required to report their worldwide income, which includes gains on these sales. The CRA will likely find out where the proceeds are – and they need to be disclosed – whether they are sitting in a foreign bank account or a Canadian one.
She said: “There's lots of ways for the CRA to find out that you sold something, so it’s a case of knowing that a transaction has to be reported. Renting out a foreign property also has to be reported on your Canadian return – and then knowing that you can claim a foreign tax credit to offset the double tax that you paid to the other country. These are things you need to navigate.”
Buying property from a non-resident raises the requirement of holding 25% of the proceeds unless there is documentation from the seller that this has been waived. If it’s not, it’s up to the non-resident to file a tax return to get some of that back.
Loeppky added: “Advisors should be aware of the rules when it comes to real estate transactions and knowing the principal residence exemption, how it works, and when you can claim it. It’s also about helping the client realize that you need to take advantage of that principal residence exemption to the best of their ability.
“Normally, they’d want to shelter that gain so helping clients make that determination is really important when they have a choice between two different properties that they could claim as a principal residence exemption.”