Tax on Assignment Sales: What You Need to Know
Real estate assignment sales and flipping pre-construction condos have become popular strategies for investors looking to make a quick return. And CRA has noticed. In this blog, I will explain two ways CRA is cracking down on pre-construction investors and what you can do to minimize your tax paid on assignment sales.
#1 – CRA May Tax Assignment Sales as Business Income
Similar to selling a resale home, you are required to report an assignment sale on your tax return and pay the necessary tax. Many real estate investors are quick to assume that the profit from an assignment sale is a capital gain.
However, CRA may tax assignment sales in two ways:
- Capital gain – where only 50% of the profit is taxable
- Business income – where 100% of the profit is taxable
To make its determination, CRA will consider factors such as:
- What was your motive or intention in buying the property?
- How long did you hold the property before selling?
- Do you have a history of similar transactions?
- What is your reason for selling?
Based on past court cases, we know that CRA will generally consider the profit from assignment sales to be business income unless you have a compelling explanation.
With the potential to double its tax collection, you can bet that CRA is watching this closely!
The Government of British Columbia has launched a database to keep track of all assignment sales in the province. This added transparency will make it even easier for CRA to scrutinize condo flipping. And, as we have seen, any real estate regulations implemented in B.C. often make their way to Ontario. (à la non-resident speculation tax)
#2 – CRA May Assess GST/HST on Assignment Sales
This is probably one of the most overlooked tax implications when it comes to assignment sales.
While resale homes are generally exempt from GST/HST, you may be surprised to learn that this may not be the case with assignments.
Similar to income tax, CRA will look at your intentions in buying the property to determine whether GST/HST applies to you.
For example, you are likely considered a “builder” and will have to charge GST/HST if you assign a pre-construction unit that you bought for the purpose of flipping to make a quick profit.
And it gets worse:
Not only do you have to charge GST/HST on your profit, you also have to charge GST/HST on the deposit you recoup from the buyer!
Since most real estate contracts embed GST/HST into the sales price, this cost will likely be borne by the assignor.
Let’s look at an example:
Scenario
Luca purchased a pre-construction condo unit for $450,000 a couple of years ago. He paid a deposit of $90,000 to the builder. The unit is currently worth $575,000. Luca had always planned to buy this unit as an investment and assign it for a profit. He has a personal tax rate of 50%.
On the surface, it looks like Luca stands to make a great profit. But, let’s see how that holds up:
At Luca’s tax rate of 50%, half of his $125,000 profit will go towards income tax. This leaves him with $62,500. Luca also owes GST/HST on his profit of $125,000 and on the $90,000 deposit. Assuming a 13% GST/HST rate, this leaves Luca with about $35,000 in net profits on the assignment sale. But, remember that Luca hasn’t even paid the builder’s assignment fee, realty commissions or legal fees yet!
What Can You Do to Save Tax on Assignment Sales?
Firstly, if you are unsure whether you have a capital gain or business income, you should reach out to a tax professional for advice.
Secondly, if the profit on your assignment sale is in fact business income because of the factors discussed above, then you should consider incorporating.
The benefit here is that business income is usually taxed at low rates inside a corporation (about 12.2% in Ontario and 11% in British Columbia). This is much lower than the the top tax rate of 53% paid by individuals.
Now be warned:
Setting up a corporation for real estate investing is not for everyone. Be sure to consult with a tax professional before implementing this strategy.
Lastly, it is important to work with an experienced real estate lawyer to discuss your GST/HST options. In my experience, it may be possible to restructure an assignment sale to reduce the GST/HST you pay as an assignor.
In Luca’s case, with the right professionals on his team, he was able to restructure the deal to reduce his taxes by about 38% (50% less 12.2%), pay less GST/HST and put this money into his next real estate project.
Have questions about flipping pre-construction real estate? Contact us for a consultation.
The content of this blog is intended to provide a general guide to the subject matter. Professional advice should be sought about your specific circumstances.
