Long gone are the days when real estate was a hot commodity that allowed to turn a quick profit. With mortgage rates still high and rental market slowing down, many investors are contemplating whether investing in real estate is still a worth it. Changes in legislation and hidden snares trigger HST payment that further reduces profits for many individuals. It is important to note that real estate investors are not the only one who get hit with taxes and hidden fees, but also individuals who purchase a property for personal use.
In this article we will discuss HST payable at the time of purchasing a property, house or a condominium, from a builder and the hidden pitfalls that will trigger HST for a buyer client and what happens if the property is sold within the first 12 months. We will also discuss HST payable on assignment sales as well as important considerations when it comes to HST self-assessment when selling a “re-sale” property. Lastly, we will address latest changes to legislation when there is a change is designation from a residential to a commercial use property if an owner decides to use their property for short-term rental such as AirBNB or Vrbo.
New Builds and HST Rules
When purchasing a single unit residential complex or a residential condominium unit from a builder, the property is subject to a New Housing HST. The amount of the tax is calculated based on the purchase price of the property. Section 254 of Exercise Tax Act (“ETA”) sets out a test and a rebate calculation for the tax. The good news is that GST/HST New Housing Rebate (“NHR”) allows an individual to recover some of the tax payable on the property. There are strict conditions that must be met before eligibility is allowed. there is a rebate in place to refund the tax back to the buyer.
The amount of rebate in Ontario is capped at $24,000 if the purchase price is $450,000 or more. For the purposes of this article, we will only be discussing properties that are over $450,000. If the price of the property is less than $450,000, there is a different calculation in place that involves a Federal as well as Provincial rebates. The first barrier for an investor is that NHR is not available to a corporation or a partnership, therefore if a buyer is a corporation or a partnership, they would have to pay full amount of NHR in addition to their purchase price.
An individual would quality for NHR if they purchased a new property from a builder for their personal use, it must become their primary residence, or a primary residence of their spouse/common law or related parties as defined by s. 251 of Income Tax Act. For clarity it is a parent (one-up), a sibling (one-over) or a child (one-down). Primary residence means that the person occupies it for more than 50.1% of the year. In this instance the builder would credit the amount of rebate on the statement of adjustments and the purchaser would not be responsible for payment of additional taxes. The purchase would sign the necessary forms with their lawyer confirming that their qualification and promise to indemnify the builder should Canada Revenue revoke their eligibility.
New Housing Rebate Rules for Investors
If the property is being purchase for investment purposes, the investor, will have to account for the fact that the builder will request that the NHR be paid up front to the builder therefore adding $24,000 to the total cost of the unit. This amount would have to be brought at the time of closing in addition to your downpayment and closing costs. There is a separate program, Landlord’s Rebate for New Residential Rental Property (“NRRPR”) for investors that allows them to recoup the rebate if qualification criteria are met. One of the main qualification criteria is that the unit is being purchased for long term investment, meaning that the unit must be rented for one year term. Therefore, if the unit is rented on AirBNB or Virbo or if the lease agreement is signed for less than 12 months term, the investor would not be able to recoup the $24,000. Therefore, an investor individual, who is buying a new property from a builder, would have to budget for additional $24,000 on closing until such time that they can receive their rebate directly from CRA after submitting their application within the allotted timeline.
Early Sales Trigger HST
Furthermore, where new build properties are sold within 12 months of purchase the seller will have to pay back NHR specifically $24,000 to CRA. Additionally, CRA may request for the rebate to be paid back should the property be sold within two years if it is deemed that the “first use” does not align with the application for NHR. For example, a rebate was allowed based on the fact that the original buyer is owner occupying the property as their primary residence. If the original buyer sells their property within the first two year and the new buyer decides to rent the property out, the original buyer may be liable for NHR repayment because the use of the property differs. How can one protect themselves? At the end of the day the original buyer cannot know the true intentions of the new buyer however, a letter or a statutory declaration by the new buyer stating that their intended use of the property could go a long way to protect the original buyer.
Tax Traps in Assignments
Assignment of your new built agreement of purchase and sale is another instance where a seller/ assignor as well as a buyer/assignee may incur additional tax implications. If the seller/assignor sells their property at a profit, new legislation dictates that HST is payable on the profit portion of the sale. It is vital that an assignment agreement is drafted correctly to ensure that the return of deposit is not included in the calculation of the profit and therefore would be excluded from HST. For example, if initial purchase price was $600,000 with a deposit of $120,000 and the seller subsequently assigned their property for $700,000, HST would be calculated on $100,000 of profit even though upon the completion of the assignment transaction the seller receives $220,000. Based on this calculation the seller/assignor would be responsible for $13,000 worth of HST, hence reducing their profit on the property.
Other taxation issue may arise when it comes to assignment transactions. The builder may automatically disqualify the buyer/assignee from benefitting from NHR resulting in the buyer having to bring additional funds that they may not budgeted on closing. This may happen regardless if an assignee is purchasing the property to use as a primary residence or planning to use it as a long-term investment, they too would have to budget for additional funds. Depending on the use of the property, the buyer/assignee could apply for the rebate through appropriate program either New Housing Rebate or Landlord’s Rebate for New Residential Rental Property directly with CRA after closing. If the buyer/assignee meets the criteria they would receive the refund of NHR. Should the buyer/assignee not meet the criteria of either of the rebate programs, they will bare financial losses and therefore reducing their profit margins.
Airbnb? Flipping Homes? Expect HST Trouble
The latest change when it comes to HST is with respect to HST charged on the sale proceeds when a property previously designated as a residential unit is converted for commercial use. This can happen when a house or a condominium is being rented out through short term rental programs such as Airbnb or Vrbo. In this situation even a re-sale unit would be subject to HST. So, if you own a property and leased it as a short term rental to make more money, CRA may deem it a “commercial” property for HST purposes.
There are however some instances where even thought part of the property is being used for short term rental, HST may not be payable. For example, if the basement was used as additional source of income by way of short-term rental and subsequently was converted to a living space to be used by the family. HST may not be payable in this case. The requirement as of now is that more than 50 % of the property is used as primary residence. The onus is on the seller to prove that the property was a primary residence and only a small portion of it was rented out on Airbnb. This puts cottage owners at a peculiar situation where they use their property but also rent it out on Airbnb for extra income. CRA will closely look at the number of days that the cottage was used as a primary residence vs number of days it was rented and make their determinations with respect to HST. Therefore, the seller must accumulate and keep all the necessary evidence to support their claim and to minimize tax liability should CRA comes for HST on proceeds of sale.
Flipping houses also attracts tax implications. The term flipping is used to describe a transaction where a house is purchased with an intension of selling it for a profit. When the property has been disposed of, we have to look at whether there was a gain or a loss. The gain or loss is based on proceeds of sale minus adjusted cost base meaning the cost that went into maintaining, renovating and disposing of the property. Once a gain was determined, characterization of that gain must also be determined. Was the gain earned on account of income specifically was it business income and therefore taxed at 100% or was it account of capital, capital gain and therefore taxable at 50%. However, there is also a concept of Adventure in the Nature of Trade that allows CRA to catch a one-off transaction if it in on account of income such as seeing a house at a very low price and intending to renovate and to re-sell it for a profit.
When it comes to real estate, CRA also looks are the buyer’s secondary intention and this is where things can get very complex. Even if purchasing a property to use as a primary residence but the secondary intention is to resell for a profit, the gain could be on account of income and therefore taxable. In some cases, the seller may face additional tax implications. Therefore, it is important note the primary and secondary intention of the seller when dealing with taxation.
There are many caveats to HST and its qualification and each situation is unique. This is a very complex topic and a more detailed review of taxes and real estate is necessary to understand its unique application. One thing is for certain, where there is a profit to be made, taxes are going to follow closely behind. However, taxes are inevitable part of real estate transactions and life in general. It is important for the buyer to educate themselves as to the taxes and HST implications that are applicable to their specific situation to determine whether the risk is worth the return.
Before embarking on an investment opportunity seek tax advice from a tax lawyer to ensure that your calculations are correct and you are going into a real estate transaction with your eyes open and knowledge of your taxation obligations. Every real estate transaction has its unique risks but with the right legal advice, you can avoid costly surprises. Contact MBLAW Professional Corporation today to make informed decisions and protect your investment.
