With real estate audits on the rise, staying ahead of tax rules has never been more crucial. The Canada Revenue Agency (the “CRA’’) and Revenu Québec have intensified their scrutiny of real estate transactions, and the federal government’s $73.1 million investment over the next five years underscores a clear message: tax non-compliance in the housing sector will not be overlooked. In this article, we explore the flipped property rule, what it means for you, and how to navigate it to avoid costly surprises.

Understanding the flipped property rule

To curb tax non-compliance in the real estate sector, the federal government introduced new rules in Budget 2022 targeting flipped residential properties, effective January 1, 2023. Property flipping refers to purchasing a residential property with the intention of reselling it quickly for a profit. The new flipped property rule deems any residential property sold within 365 days of purchase as business income, regardless of the seller’s intention. This rule applies even if the property was initially purchased as a personal residence or for long-term investment purposes.

Under this rule, gains from the sale of residential properties owned for less than 365 days are fully taxable as business income, meaning they are no longer eligible for the 50% capital gains inclusion rate or the principal residence exemption.

The only exceptions to this rule are specified by legislation and include certain life events, such as:

  • death;
  • marital breakdown;
  • family additions;
  • disability;
  • insolvency;
  • job relocations;
  • involuntary termination of employment; and
  • threats to personal safety or expropriation.

Additional legislation released in August 2024 (though not yet in effect due to a suspension in Parliament) introduces an exclusion for deemed dispositions by a trust upon the death of a beneficiary. This provision clarifies how property transfers are treated in the event of a beneficiary’s death.

In cases where the rule applies, reasonable expenses incurred to earn the income, such as property maintenance or transaction fees, are tax-deductible. However, any resulting loss from the sale cannot be claimed as a business loss.

Transactions to watch for

Despite the straightforward nature of the flipped property rule, some situations may unintentionally fall within its scope, potentially causing confusion for taxpayers. For example, consider a family trust that owns a residential property used as a primary residence by one of its beneficiaries for many years. Before 2017, family trusts could claim the principal residence exemption for property occupied by a qualifying beneficiary. However, rule changes in 2017 now require trusts to distribute the property to the beneficiary, enabling the beneficiary to claim the principal residence exemption for the years the trust owned the property.

The issue arises if the trust distributes the property to the beneficiary within 365 days of its sale. In such cases, the flipped property rule would likely apply, preventing the beneficiary from claiming the principal residence exemption and instead converting any gain into taxable business income. This situation highlights the importance of understanding how the 365-day rule can affect transactions involving family trusts.

In 2024, the CRA issued further clarifications regarding the application of the flipped property rule in corporate contexts. The rule will apply in the following scenarios:

  1. When two corporations amalgamate, and the newly amalgamated entity sells residential property within 365 days of the merger.
  2. When a parent corporation receives residential property from its subsidiary due to a wind-up and sells the property within 365 days of the wind-up.
  3. When a corporation transfers residential property to a related corporation as part of a rollover under section 85 of the Income Tax Act, and the related corporation sells the property within 365 days.

These clarifications emphasize that the flipped property rule applies broadly across various property ownership structures – not only to individual buyers and sellers but also to trusts and corporations. Taxpayers involved in such transactions must be aware of the specific rules and exceptions to avoid unexpected tax consequences.

Miller Thomson’s Tax Group can help you navigate the complexities of the flipped property rule. Whether you’re dealing with property sales, trust distributions, or corporate transactions, we provide tailored advice to ensure compliance, minimize risks, and optimize your tax strategy. Let us guide you through these changes and protect your interests.