DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Posts Tagged ‘Real Estate’

Sold your House? Make Sure You Report It!

In Canadian Income Tax, Estates and trusts, Non-residents, Personal Tax, Principal Residence on November 18, 2016 at 8:31 pm

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If you have sold your home recently, you should take note of the new reporting rules announced by the CRA regarding the principal residence exemption (“PRE”).

The PRE applies on a pro-rata basis based on the number of years you are claiming the house as your principal residence. Form T2091 is technically required to report and claim the PRE on the sale. If you were claiming the exemption for the full period of ownership, then the gain on the sale is fully exempt from tax. The CRA’s policy until now has been that no reporting was required in such a case.

However, for 2016 and future years, this administrative policy has changed. Form T2091 is still not required if the full exemption is claimed, However, the sale must be reported on Schedule 3 of your tax return for the year. You will need to report a description of the property,  the year of acquisition and  the proceeds of disposition. Failure to report the sale will result in the denial of the PRE. However, you may go back and amend your return to report the sale and claim the exemption, subject to possible penalties of $100 per month to a maximum of $8,000.

For Quebec tax reporting, there has never been any administrative policy regarding a fully exempt sale of a principal residence and form TP-274 continues to be required.

Changes for Trusts

If your principal residence is owned by a trust, new rules will apply to you. I outlined the current rules in a previous post.

Under the new rules, only certain specialized trusts are now eligible to claim the PRE. They are alter-ego trusts, certain spousal or common law partner trusts, certain protective trusts or certain qualified disability trusts.

Starting in 2017, any trust that owns a home and does not fit within any of the categories above, will no longer be eligible for the PRE on the sale of the home. Therefore, if the house is sold before the end of 2016, the PRE can still be claimed.

For 2017 and later years, a home that was owned by a trust that no longer qualifies for the PRE will be allowed to calculate the exemption based on transitional rules that would require a valuation of the property as at the end of 2016. The PRE will be available for the “notional” gain up to the end of 2016, while the future growth in value will be subject to capital gains tax.

Anyone who currently lives in a home owned by a personal trust should consult their tax advisor.

Changes for Non-Residents

New rules will also apply to anyone who was a non-resident at the time they purchased a residential property in Canada. Under the current rules, the pro-rata formula that is used to calculate the PRE allows for an extra year (the plus 1 rule) in calculating the exemption. This generally allows for the fact that in a year where someone sells their home, they may own two properties, both of which should qualify for the exemption.

For a non-resident, the plus 1 rule allowed them to claim a portion of their gain as exempt, even though they never qualified since they were non-residents of Canada. Accordingly, for all sales on or after October 3, 2016, the Plus 1 rule will no longer be available to any taxpayer who was a non-resident of Canada in during the year in which he or she acquired the property. There are no transitional rules to this provision.

What’s Your Tax Issue? Residence in a Trust

In Canadian Income Tax, Personal Tax, Principal Residence on January 7, 2012 at 8:19 pm

Our House is a very very very fine house

                  –Crosby, Stills, Nash & Young

The Tax Issue

I am a member (beneficiary) of a family trust that was set up years ago by my Dad. The trust currently owns two houses. I live in one, and my sister, who is also a member of the trust, is married and lives in the other. We were told that we will have taxes to pay we sell our homes. Can this be true? Please help, as no one seems to know the answer.

The Answer

The principal residence rules that apply to personal trusts are surprisingly restrictive and can be a trap for the unwary.

A trust is treated as a person for tax purposes. As such, it does have access to the principal residence exemption on the sale of a home. But here’s the kicker: if a trust designates a home as a principal residence for a given year, then every beneficiary of that trust who lived in or used the home owned by the trust is deemed to have made the designation. And remember, a person can only designate one property as her principal residence. This applies to a trust as well. This means that if the trust sells the home you are living in and claims it as a principal residence, then when the trust sells your sister’s home, the trust is precluded from making the designation on the second home. Her home becomes ineligible for the exemption for those years even though it may be the only home she’s lived in. This might come as a shock, and it seems unfair, but that is the way the law works.

So, let’s look at an example. Say the trust owned your home since 2000 and it is sold in 2012 at a gain of $500,000. Furthermore, let’s assume the trust owned your sister’s home since 1996, and sells in 2012 at a gain of $400,000. If the trust claims the full principal residence exemption on your home, then it will be precluded from claiming the exemption for the years 2000 – 2012 on your sister’s home. In fact, for the 16 years the trust owned your sister’s home, only 4 will qualify, so only 4/16 of the gain will be exempt. (Actually, the formula generously adds 1 year to numerator, so technically 5/16, or $125,000 of the total gain will be exempt).

Also, if a trust claims the principal residence exemption on home, then all beneficiaries of that trust who may have used the home are deemed to have used their own principal residence exemptions on that property. So, for example, if a summer cottage is owned by a trust and is used by all the family members, some of whom own their own homes, they could lose their exemptions if the trust claims the cottage as a principal residence.

Taxpayers thinking about placing personal homes in a family trust should always seek professional tax advise.

What’s Your Tax Issue? 69 Problems

In Canadian Income Tax on August 24, 2011 at 9:56 am

The Tax Issue:

As we speak, I’m studying for my corporate tax midterm and my teacher has told me something that doesn’t make much sense.

According to section 69, if a transaction with a non arms length person occurs at below fair market value (FMV), the adjusted cost base (ACB) to the purchaser will be the actual amount paid.

OK, fine.

Then, under subparagraph 13 (7)(e)(iii), the undepreciated capital cost (UCC) to the purchaser will be the FMV and the cost base will be the same ACB of the vendor, the difference between the two being deemed capital cost allowance (CCA)…

Say what?

Here’s an example of a building:

Capital cost to vendor: $325
FMV: $200
Actual sale price: $180.

Under section 69, the ACB of the purchaser will be $180; OK fine.

Now, under section 13 (7)(e)(iii), the UCC will be $200 with a capital cost of $325, the $125 being deemed CCA…

Don’t these provisions contradict themselves?

The Answer:

Since you are studying for your midterm, I’ll try to answer quickly.

Section 69 has been discussed in a previous post. It makes only a one-way adjustment to the proceeds to the seller in a non-arm’s length sale below FMV. It remains silent on the consequences to the purchaser. In a normal case of non-depreciable property, therefore, the cost to the purchaser remains the price paid as you have stated.

However, special rules for the purchaser kick in when he has purchased depreciable property. Subparagraph 13(7)(e)(iii) is there to ensure that a non-arm’s length purchaser does not turn a future recapture of depreciation (fully taxable) into a capital gain (half taxable).

First of all, if you read the preamble in paragraph 13(7)(e) it applies “notwithstanding any other provision of the Act”, so it overrides section 69.

Next, it doesn’t change the cost of the property to the purchaser, it simply designates it as UCC, and tacks the seller’s original capital cost on top so that a future sale triggers a recapture of depreciation to the extent that the original vendor would have a recapture, thus preserving the original tax treatment of capital cost.

In your example, the UCC will be the actual cost to the purchaser, being $180. This is true under both section 69 or under 13(7(e)(iii). The effect of 13(7)(e)(iii) is to deem the capital cost to be $325, so if the property is eventually sold for, say $400, there will be a recapture of $145 (325-180), which is fully taxable and a capital gain of only $75 (400-325), which is 50% taxable.

Good luck on your mid-term!!

GST and Real Estate

In Canadian Income Tax, Goods and Services Tax, Real Property on February 3, 2010 at 4:10 pm

Transactions involving real estate seem to attract hectares of GST questions. Surprisingly, the basic rules are fairly straightforward. Unfortunately, there are many “out of the ordinary” situations that complicate matters. Happily, those will not be covered here. The rules discussed below deal with most transactions practitioners will ever encounter.

Before purchasing real estate, make sure to check the GST rules

What is Taxable?

Real estate transactions fall into two main categories: Supply by way of “lease or licence” (i.e., “rentals”), and supply by way of sale.

Generally, as is the case with all GST questions, the first rule is that every supply is taxable unless it qualifies for an exception. Thus, most commercial real estate transactions involving businesses will be taxable. The major GST exemptions will involve supplies of residential property.

The long-term rental of residential property is generally exempt.

A sale of property is exempt if it qualifies under the definition of “used residential” property. Generally, a residential property is considered used if it was previously occupied or intended for use by an individual as a personal residence.

New Residential Property

A sale of a new residential property is taxable. Generally, it is a “builder” who will make such a sale. Since the builder is himself carrying on a commercial activity, he will be claiming input

tax credits (“ITC”) on his construction costs, and then charging the GST when he sells the property.

The purchaser of a new home will be eligible for a “new housing rebate”. This rebate is equal to 36% of the GST paid up to purchases of $350,000. Between this amount and $450,000, the rebate is reduced, and is eliminated thereafter (for the QST, the dollar limits are $200,000 to $225,000).

Self Supply of Residential Property

If a builder, rather than selling a completed residential complex, decides to retain it as a rental property, the “self supply rules” will apply. He will be deemed to have sold himself the property. He will self-assess and remit GST based on the fair market value of the property, including the land. This tax is not eligible for an ITC, since it is an acquisition of a residential property. It will, however, qualify for the residential rebate. If the complex is an apartment building with many units, its value will likely exceed the $450,000 limit. However, these limits will apply to each unit based on its square footage. Accordingly, if a builder completes a 5 unit apartment whose value is $1 million, each unit might be valued at $200,000 and will qualify for the full rebate.

These self-supply rules will apply equally to a “substantial renovation” of a residential property.

Input Tax Credits

Generally, any GST registrant carrying on a commercial activity is entitled to an ITC for expenses. If the activity of the purchaser is part commercial and part exempt or personal, then the ITC must be apportioned in a reasonable manner.

For capital property other than real estate, if the property is used more than 50% in commercial activities, it will be eligible for a full ITC.

A purchase of real property is subject to unique rules. Generally, the ITC must be apportioned based on commercial use. If the purchaser is an individual, no ITC is available at all if the property is used primarily (>50%) as a residence. Thus, an accountant who uses 20% of her home as an office cannot claim any ITC on the real estate purchase.

Who Collects

Generally, a vendor of real property is responsible for collection and remittance of the GST. However, this is not the case where the purchaser is a GST registrant. In this case, the purchaser will self-assess the GST and simultaneously claim any eligible ITC. The vendor should verify the purchaser’s registration number with the government.

If the sale of real property is exempt, it will be because of the vendor’s history with the property. The purchaser should insist on a written confirmation of exempt status from the vendor. Otherwise he will be liable for the tax if such status is subsequently denied for any reason.

Wright is Wrong….Again!!!

In Canadian Income Tax, Non-residents on January 5, 2010 at 4:04 pm

Once again, I am personally forced to swallow a tough court decision, as the case of Pechet v. The Queen (2009 DTC 5189) has been dismissed by the Federal Court of Appeal. This case overturned the informal procedure Tax Court decision of Wright v. The Queen (2001 DTC 437) originally argued  (and won) by yours truly.

The Wright case dealt with interest on unpaid non-resident withholding taxes. Under Part XIII of the Act, anyone paying rent to a non-resident must withhold tax based on the gross amount paid. The rate is 25% unless reduced by treaty. The basis for withholding may be reduced to the net amount after expenses if an undertaking is filed with the CRA and form NR6 is filed. (For more, see my post on Non-resident Real Estate Investors)

If the non-resident recipient files an income tax return under section 216 of the Act by the required deadline, tax under Part I of the Act is applied “in lieu of” the Part XIII tax withheld. In essence, any tax withheld in excess of the Part I liability is refunded.

Where the Part XIII tax is not withheld, but the section 216 is filed, the CRA’s position is to charge interest based on the withholding tax that should have been remitted. The original argument in Wright was that if the filing of the 216 return replaces the Part XIII liability with the Part I liability, then there is no longer any tax upon which an interest calculation may be made. The Tax Court agreed, and a loophole seemed to be exposed.

The Pechet case heard in Tax Court overturned Wright, but there was still a glimmer of hope as it was appealed to the Federal Court of Appeal.

Now, sadly, it appears my own personally victory remains just that. Since decisions in  the informal procedure cannot be appealed, my client’s victory is final and my Tax Court record is still 3-0. However, my legacy as a precedent-setting barrister is over for good.

The Court of Appeal in Pechet upheld the decision of the lower court and concluded that the filing of a return under section 216 of the Act does not retroactively eliminate the requirement to withhold under Part XIII. Rather, the withholding requirements continue to apply, up until the point in time when the tax liability of the non-resident has shifted from Part XIII to Part I. The phrase “in lieu of” does not mean that the Part XIII liability never existed, but that it is replaced, at the time of the filing of the return, with the Part I tax liability. Any interest accruing on unpaid withholding tax up to that point must be paid.

This interpretation, in all fairness, seems to be the correct application of the provisions, given the scheme and intent of the Income Tax Act as it applies to non-resident taxpayers.

What’s Your Tax Issue? Gift or Sale to Kids

In Canadian Income Tax, Personal Tax on November 19, 2009 at 6:11 pm

The Tax Issue:

I am a partner in a Canadian co-ownership of real estate rental property and my siblings and my mother are also part owners. I would like to make a gift of my share to my children. Can this be done tax-free? Could I sell the property to them for a dollar?

The Answer:

In Canada, we don’t have a gift tax. However, when a gift is made between family members there is a deemed disposition at fair market value. So any gain that has accrued on your share of the co-ownership will be realized and you will be taxed. I’m not sure of your particular situation, but you might want to check your 1994 income tax return (if you can find it). That’s the year that the $100,000 general capital gains exemption was repealed. A special election was available to make one final use of the exemption and “bump up” the cost base of capital assets. If  you made the election on your real  estate venture, that could shelter part of the tax on a future disposition.

Special rules would also apply to your kids if you make this gift to them. Their cost amount for depreciation purposes could be reduced by the amount of your proceeds that results in the non-taxable portion of a capital  gain.

One of my pet peeves is when people make the mistake of thinking that a sale for a dollar is the same as a gift. It isn’t. A sale at an amount less than fair market value is not a gift, and different, much harsher rules apply. Your proceeds will still be equal to fair market value, but the cost base to the purchasers will be equal to exactly what they pay, i.e. one dollar. Then, when they decide to sell, they would be paying tax again on the full amount of proceeds. This “double tax” is the penalty for making a sale to a related person at an amount less than fair market value.

Non-Resident Investors In Canadian Real Estate

In Canadian Income Tax, Non-residents on September 29, 2009 at 5:20 pm

Maybe it’s the global warming thing, but Canada has suddenly become a very popular destination for non-residents (“NR”) investing in real estate. What are the tax rules for non-resident investors, and what investment vehicle should be used?

Non-Resident Investors

A NR investor is subject to withholding taxes under Part XIII of the Act. Generally, 25% of gross rents must be remitted to the CRA each month. An election under section 216 may be made. Under this election, the NR files a tax return and is eligible for the same deductions as Canadian residents including capital cost allowance. However, it does not entitle the NR to loss carryovers from prior years.

A survey of the tax rules would be advised prior to investing in Canadian real estate

A survey of the tax rules would be advised prior to investing in Canadian real estate

If form NR6 is filed, the NR undertakes to file a return within 6 months from the end of the year, and the tax withheld is reduced to 25% of the estimated income after deductions. Where no undertaking is filed, the tax withheld is 25% of the gross rent, but the deadline for filing a return is extended to 2 years.

Under certain circumstances a NR paying interest to another NR may also be subject to withholding taxes on the interest payments.

A NR corporation would be subject to further withholding requirements known as branch tax. This tax is intended to equal dividend withholding tax on profits repatriated out of Canada by the NR corporation. The branch tax rates are similar to withholding rates for dividends, subject to treaty reductions. NR corporations are also subject to tax on capital in certain provinces. Finally, an NR corporation may be subject to “thin capitalization” rules that restrict interest deductions.

A NR trust pays no branch tax or tax on capital. Losses of a trust , however, cannot be flowed out to beneficiaries.

Using a  Canadian Investment Vehicle

The two major choices for a Canadian investment vehicle is the Canadian resident trust or the Canadian corporation.

A Canadian corporation is subject to the full rates of tax on investment income. Unless it qualifies as a Canadian controlled private corporation, no part of the taxes payable will be refundable upon the payment of dividends. Dividend payments will be subject to withholding taxes of 25%, unless reduced by treaty. Further, in certain provinces, a Corporation is subject to tax on capital. Thin capitalization rules apply as well. These factors make this vehicle an unpopular choice for most NR investors.

A Canadian trust is not subject to tax on capital. Nor would the payments to beneficiaries of after-tax income be subject to any withholding taxes. Thus, the trust would be subject to tax only once, at the highest marginal tax rates for individuals. This rate could vary, depending on the province of residence of the trust.

Dispositions of Real Estate by Non-Residents

As taxable Canadian property, a gain on the disposition of real estate by a non-resident is generally subject to Canadian tax at Canadian rates for capital gains and recaptured capital cost allowance.

Withholding taxes must be remitted, and may be based on the gain on sale only where a withholding tax certificate is obtained under section 116 of the Act. If no certificate is requested by the due date (either before the sale, or within 10 days following the sale), then the purchaser is required to withhold based on the gross purchase price. The withholding rate is 25%. An additional 12% applies for the province of Quebec, which has its own certificate request procedure under Article 1097.

One common problem that arises when a NR disposes of Canadian real estate is that a 116 certificate will only be issued if all the withholding requirements have been met in the past. That is, if no returns were filed under section 216, then the CRA will require remittance of 25% of gross rents for the previous years plus interest. If the 2 year deadline has passed, the CRA will normally not accept late-filed 216 returns.