Category Archives: capital gains tax

CRA cracking down on abuse of principal residence exemptions, but their assessments aren’t written in stone

The sale of one's home offers Canadians the best opportunity for a major tax-free gain.
The sale of one’s home offers Canadians the best opportunity for a major tax-free gain. PHOTO BY DAVID ZALUBOWSKI/AP PHOTO FILES

There are very few things that are tax-free: investment income in your TFSA, lottery and casino winnings, purchasing six or more doughnuts (see what happens to the GST/HST next time you try it) and the gain from the sale of your principal residence are among the limited exceptions. With the odds of winning the lottery being slim at best, it’s the sale of one’s home that offers Canadians the best opportunity for a major tax-free gain.

In recent years, however, the Canada Revenue Agency has been cracking down on taxpayers who, in its view, are inappropriately claiming the principal residence exemption (PRE), particularly as it relates to flipping houses. If it’s determined that you’re regularly buying and selling homes, you can be denied the PRE, and be taxed on any profits as 100 per cent taxable business income, versus 50 per cent taxable capital gains. Take the recent case, decided in September, of an Ontario couple who bought and sold multiple homes between 2007 and 2012.

The couple, who live in the Ottawa area, bought and sold houses in each of 2007, 2008, 2009, 2011 and 2012 and claimed the PRE to shelter the gain on each sale from tax. The CRA disagreed and sought to tax the income from the disposition of each of the five houses as business income. The CRA also levied gross negligence penalties.

Homes #1, #2 and #3

The taxpayer operated a concrete pouring business, and later, a foundation repair business.

In August 2006, the couple bought House #1. After moving in and doing some renovations and painting, they soon became dissatisfied with the house — it was located close to an industrial site and large trucks passed the house from 6 a.m. until late at night. The noise from the trucks was loud and the vibrations made the house shake. As a result, the couple, having only lived there for approximately ten months, decided to move, selling the home for a gain of $69,801 in 2007.

They then constructed House #2, their “dream home,” with substantial upgrades, and moved in September of 2007; however, the couple “quickly became unhappy with the neighbourhood…(and)…became concerned for (their twin) girls’ security, due to a ‘coyote invasion.’” The couple sold the home, moving out in Aug. 2008 having lived there for eleven months. The profit from the 2008 sale was $273,434.

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The following month, the couple moved into House #3, which they had constructed. Soon after they moved in, the real estate agent who had sold them their prior home approached them and asked if he could show their new house to his clients who apparently made an offer that the taxpayer couldn’t refuse. It was sold in Sept. 2009 for a substantial profit of $403,776 above the cost of the land and construction.

Houses #4 and #5

In Dec. 2009, the couple moved into newly purchased House #4, a townhouse on which they had made improvements. It turned out that the townhouse “was not a good buy” for the couple: the taxpayer’s truck was too large to be parked properly in the laneway and the neighbours complained about the couple “having loud social gatherings.” In Jan. 2011, they sold the home for a profit of $54,913.

They then moved into Home #5, making some improvements and doing some landscaping. But, in the end, this home, too, was “not their dream home,” and they sold it and moved out in July 2012, making a profit of $187,574. After selling it, they moved into a sixth home, where they still resided at the time of the trial.

The decision

In determining whether the sale of real estate is considered business income, the courts have traditionally considered the following factors: the nature of the property sold and how the taxpayer used it; the length of the ownership period; the frequency or number of other similar transactions by the taxpayer; the work expended on or in connection with the property; the circumstances giving rise to the sale of the property; and the taxpayer’s motive regarding the sale of the property at the time of purchase.

At the time of each purchase, the couple argued that it was clear that their motivation was not to sell the houses, testifying that “if their motivations had been to sell the houses at a profit, they would have not customized the houses and added the many upgrades.”

With respect to the sales in 2007, 2008 and 2009, the taxpayer also argued that it was too late for the CRA to reassess those tax years as they should be considered “statute barred.” The CRA is generally prohibited from reassessing an individual taxpayer more than three years after the original reassessment unless it can be shown that the taxpayer made “a false statement attributable to misrepresentation arising from carelessness, neglect or wilful default.”

Each year, the taxpayer consulted his accountant to obtain professional advice at the time of filing his tax returns. He explained to his CPA that his intentions were to stay in the houses, but “for legitimate reasons and circumstances beyond his control, he and his spouse had decided to sell the houses.”

The judge agreed that there was no misrepresentation attributable to neglect, carelessness or willful default. “It is clear … that simply because a taxpayer has adopted a position that contradicts the (CRA’s) position does not in itself mean a taxpayer has made a misrepresentation that would allow the (CRA) to reassess after the normal period.” Thus, the CRA was precluded from reassessing the taxpayer on the sales of Home #1, #2 and #3 in the three statute-barred years.

The judge, however, was of the view that the taxpayer’s “primary intention at the time of purchase of both (House #4 and #5) was to resell them at a profit. If it was not his primary intention, then the possibility of reselling them at profit was certainly a secondary intention motivating him to purchase both houses.” She thus ruled that the PREs did not apply to the gains on the sales of Houses #4 and #5 and they were properly taxable as business income.

Finally, the judge dismissed all gross negligence penalties assessed by the CRA since the taxpayer, based on the advice of his accountant, was under the impression that he could claim the PRE each year. As she wrote, “In my view, the (CRA) did not establish that (the taxpayer) knowingly make a false statement or omission when filing his income tax returns for the 2011 and 2012 taxation years.”

Note that since 2016, you are required to report all dispositions of a principal residence on Schedule 3 of your tax return, making it much easier for the CRA to review your PRE claim.

Source: Financial Post November 6, 2020: Jamie Golombek, CPA, CA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.

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Cash Flow vs Capital Gains: The 2 Types of Investment Income

Cash Flow vs Capital Gains by Kim Kiyosaki

Making money through cash flow versus capital gains

How do you currently make money? By going to your job every day and collecting a biweekly paycheck in exchange for your work? Most people make money this way, because it’s what they are taught to do by their parents or teachers. Also, it feels like a safe and secure path because it’s the traditional route.

Well, what if I told you that there’s another way? Another path in life that doesn’t require you to trade time for money? A path that allows you to follow your passion, achieve financial freedom, and reach your life goals? Now I’ve piqued your interest, right?

This path is precisely how the rich make their money — and it’s not from an hourly wage or salary. Instead, they make their money from their investments. In fact, the best way to make money is as an investor — but the question I’m often asked is: How do you make that money? If your monthly income as an investor does not come from a job, then where does it come from?

Making Your Money Work for You

If there’s one thing the rich do differently than the poor, it’s that they put their money to work instead of working for their money. What does that mean? Their money isn’t just sitting around in a savings account, accruing little-to-no interest, waiting for a rainy day. Their money is being invested — and delivering a return!

Different investments produce different results. The question is, what results do you want?

There are two primary outcomes an investor invests for:

Investor Income #1: Capital Gains

If you enjoy watching those “fix it up and flip it” TV shows, you’re probably already familiar with the concept of capital games — essentially, it’s the game of buying and selling for a profit.

In real estate, let’s say you buy a single-family house for $100,000. You make some repairs and improvements to the property, and you sell it for $140,000. Your profit is termed “capital gains.” Any time you sell an asset or investment and make money, your profit is capital gains. Of course, there are also capital losses (which occur when you lose money on a sale).

The same concept holds true outside of real estate. If you buy a share of stock for $20, and sell it once the stock price increases to $30, that’s also a capital gains profit.

The Problem with Capital Gains

While there is money to be made through capital gains, it’s also important to note the risks.

First, it’s a formula you have to keep repeating over and over again — you have to keep buying and selling, buying and selling, and buying and selling, or the game and the income stop.

Second, if the real estate market takes a nosedive, “flippers”— people who buy a real estate property and quickly turn around and sell it for a profit, or capital gains — can get caught with inventory they can’t sell.

Before the housing bubble burst in 2008, the mindset for many was that the market would continue to go up. So, when the market reversed and crashed, the properties were no longer worth what the flippers bought them for, and there were no buyers to flip the properties to. This led to a record-breaking number of foreclosures, and people simply walking away from homes.

Most investors today are chasing capital gains in the stock market through stock purchases, mutual funds, and 401(k)s. These investors are hoping and praying the money will be there when they get out. To me, that’s risky.

As long as market prices go up, capital-gains investors win. But when the markets turn down and prices fall — something nobody can predict — capital-gains investors lose. Do you really want that gamble?

Investor Income #2: Cash Flow

Cash flow is realized when you purchase an investment and hold on to it, and every month, quarter, or year that investment returns money to you. Cash-flow investors, unlike capital-gains investors, typically do not want to sell their investments because they want to keep collecting the regular income of cash flow. If you aren’t already familiar with my motto, cash flow is queen!

If you purchase a stock that pays a dividend, then, as long as you own that stock, it will generate money to you in the form of a dividend. That is called cash flow. To cash flow in real estate, you could purchase a single-family house and, instead of fixing it up and selling it, you rent it out. Every month you collect the rent and pay the expenses, including the mortgage. If you bought it at a good price and manage the property well, you will receive a profit, or positive cash flow.

The cash-flow investor is not as concerned as the capital-gains investor whether the markets are up one day or down the next. The cash-flow investor is looking at long-term trends and is not affected by short-term market ups and downs — what a great position to be in!

The Advantage of Cash Flow versus Capital Gains Investing

The best thing about cash flow is that it’s money flowing into your pocket on a continual basis — whether you’re working or not. You could be on the golf course, jet-setting around the world, watching Neflix in your jammies, or building a business, and your money is busy working for you. And generally, cash-flow investing is based on fundamentals that aren’t as susceptible to market swings like capital-gains investments, which means that even in bad times, money still flows into your pockets.

Additionally, cash flow is what is known as passive income, which is the lowest taxed type of income. This is not always the case with capital gains taxes, which vary depending on the type of asset you’ve invested in and how long you’ve owned that asset. In some cases, the taxes can be very high.

If you’re ready to start enjoying the lifestyle advantages of cash flow, don’t miss my recent blog on getting started with real estate.

Source – RichDad.com – Kim Kiyosaki Original publish date: September 12, 2013 (Lastupdated:April 18, 2019)
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Capital gains explained

Source: MoneySense.ca – by   

 

Capital gains explained

How it’s taxed and how to keep more for yourself

What is it?

You have a capital gain when you sell, or are considered to have sold, what the Canada Revenue Agency deems “capital property” (including securities in the form of shares and stocks as well as real estate) for more than you paid for it (the adjusted cost base) less any legitimate expenses associated with its sale.

How is it taxed?

Contrary to popular belief, capital gains are not taxed at your marginal tax rate. Only half (50%) of the capital gain on any given sale is taxed all at your marginal tax rate (which varies by province). On a capital gain of $50,000 for instance, only half of that, or $25,000, would be taxable. For a Canadian in a 33% tax bracket for example, a $25,000 taxable capital gain would result in $8,250 taxes owing. The remaining $41,750 is the investors’ to keep.

The CRA offers step-by-step instructions on how to calculate capital gains.

How to keep more of it for yourself

There are several ways to legally reduce, and in some cases avoid, capital gains tax. Some of the more common exceptions are detailed here:

  • Capital gains can be offset with capital losses from other investments. In the case you have no taxable capital gains however, a capital loss cannot be claimed against regular income except for some small business corporations.
  • The sale of your principal residence is not subject to capital gains tax. For more information on capital gains as it relates to income properties, vacation homes and other types of real estate, read “Can you avoid capital gains tax?
  • A donation of securities to a registered charity or private foundation does not trigger a capital gain.
  • If you sell an asset for a capital gain but do not expect to receive the money right away, you may be able to claim a reserve or defer the capital gain until a later time.

If you are a farmer or a newcomer to Canada, they are special capital gains rules for you. The specifics can be found at the CRA website.

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7 ways the tax man is watching you

tax man is watching you

CRA is scouring your social media & donning disguises

Whether it’s through a photo on social media or a casual conversation with a friend, the Canada Revenue Agency is always watching and listening. And their investigators will pursue you tirelessly if they think you’ve been lying on your tax return. Their subject of choice? These days, it’s anyone and everyone.  “We always think it’s only the rich who the tax man is interested in but it’s the little fish they like the best,” says Paul DioGuardi, a senior tax lawyer and author of The Taxman is Watching. “The Internet is becoming a favoured weapon for the CRA to find and analyze all kinds of data so they can watch people they think are cheating on their taxes.”

Here’s five ways the CRA may be watching you that you probably weren’t aware of.

1. Your social media

Any of your open social media accounts are publicly accessible and some posts could prompt a CRA investigation into your financial life. From the CRA’s point of view this is a legitimate practice on their part because posts on social media really aren’t private. How does this work? Say you just bought a new $85,000 sail boat and are boasting about it by posting a photo of it on Facebook. The CRA could see this and then check it against what you declared as income last year. “If you declared $40,000 in annual income, or a modest amount, they’re going to be suspicious and come calling,” says DioGuardi.

2. Your sales and purchases on Kijiji, Etsy and Ebay

Is your passion for vintage furniture really a hobby? Or are you running a small business from your living room and not declaring the profits on your tax return? “To compare this data would take years in the old days,” says DioGuardi. “Now the CRA can data-mine these non-traditional sources of info in a heartbeat pretty much whenever they like. They are a collection agency with police-like powers.”

3. Your small business’s sales data

Cheating on your company sales numbers by declaring lower revenue than is actually the case?  Don’t. The CRA is able to use data to plow through years’ worth of your credit card transactions with the aim of matching your stated sales with electronic data they’re able to access.

4. Bank accounts and investments

To spot undeclared, taxable interest, dividend and capital gains income, the CRA has access to info from all Canadian financial institutions. They can also determine if you’ve exceeded your TFSA and RRSP contributions and penalize you accordingly.

5. Capital gains from condo and real estate sales

“In the old days I had to go to the registry office to find out when a piece of real estate had been bought and sold,” says DioGuardi. “Not anymore. The Internet changes the game.” Now, the CRA can look at all real estate transactions and easily flag suspicious transactions. What are they looking for? Condo flippers and real estate sales where the owner hasn’t declared capital gains and paid the appropriate taxes. Multiple property ownership where the taxpayer isn’t also declaring rental income is another trigger for investigation.

6. Your income and pensions

The CRA is hunting for disparities in retirement income. It can access info on your bank account balances and income and match it with previous tax returns. If there’s a wide discrepancy, be prepared to answer more questions.

 7. Mystery shopping

Don’t be surprised if CRA agents show up at your restaurant or other small business, in disguise to eat a meal with the intention of rooting out suspicious financial behaviour. The agents could pose as a couple out for a meal to see how your business works and what the count is for people frequenting your business to ensure it is aligned with what you have reported in previous tax returns. “It’s a big job and I think they will sub-contract a lot of this out in future,” says DioGuardi.

What does all of this mean? That the shift of responsibility is really shifting to the taxpayer and not the tax collector. In the past, the tax man simply told you what you owed.  These days it’s completely up to you to declare what you should be paying, and they have the means to check that what you’re saying is absolutely accurate. “Remember, they can search anything, put liens on your property and slap you with penalties and late fees,” says DioGuardi. “My suggestion is to always give full and complete disclosure on your annual tax return. With data mining the way it is today, if you don’t, then believe me, they will find you.”

Source: MoneySense.ca – by  

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Reporting the sale of a rental property

Q:  I bought a house in 2010 for $600,000 and lived in that house as my principal residence until 2013.  Then I bought and moved into another property. I rented out the first house and reported all income on my tax returns. In 2016, I sold the rental property for $900,000. When I file my tax return for 2016, how much capital gains am I supposed to declare and report to the CRA?  Is it $900K minus $600K, minus the cost of disposition; or $900K minus whatever the deemed fair market value of the property at the time when I moved out in 2013, minus the cost of disposition?      

— Wallace, Toronto


Ayana Forward is a Certified Financial Planner with Ryan Lamontagne Inc. in Ottawa: 

You are entitled to a principal residence exemption for the time you lived in the residence—between 2010 and 2013. The formula for calculating your principal residence exemption also includes an extra year so you will have four years of exemption according to the formula.

The formula is as follows:
((# of years home is principal residence + 1)/# of years home is owned) x capital gain

Your capital gain before factoring in the principal residence exemption is your proceeds of disposition ($900,000) minus your purchase price ($600,000), which works out to $300,000.

Using the above formula, your principal residence exemption is:

((3 + 1)/6)  x $300,000 = $200,000

Your capital gain after factoring in the principle residence exemption is $100,000 (as $300,000 minus $200,000 = $100,000). Because it’s a capital gain, the CRA will only charge you tax on 50% of that gain, resulting in a taxable capital gain of $50,000.

The amount of tax you pay on that $50,000 will depend on your marginal tax rate.

To report the sale and tax owed, you must complete form Form T2091(IND) Designation of a property as a Principal Residence by an Individual (Other Than a Personal Trust) and file it with your income tax return.

Source MoneySense.ca –  Ayana Forward  is a real estate investor who also holds the Certified Financial Planner (CFP®) designation. Ayana is fee-based Financial Planner with Ryan Lamontagne Inc in Ottawa, ON.

 

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