My family and I just came back from one week long vacation in Florida.
Despite the flight delay which caused us to miss the cruise we were supposed to go on, the weather was fantastic and the Ft Lauderdale beach was great.
Robin was a happy girl at the beach waving ‘hello’ to everyone. We even managed to get a tan!
While I was away, I saw this interesting Financial Post article about a Montreal woman who ran into some tax trouble.
And it got me thinking…
When we discussed about Rent to Own Taxation, we examined the criteria that is used by various court cases to evaluate the transaction as business or capital in nature (investment). The same criteria also applies to this case mentioned in the Financial Post.
The Montreal lady was ruled by CRA that income generated from flipping her properties should have been reported as income, as opposed to the more preferred treatment – capital gain (only 50% of the gain is taxable).
If she intended to operate a business of flipping houses from the beginning, my recommendation to her is to incorporate and operate the flipping business within the protection of corporation.
I consider flipping houses having a higher risk profile than straight rental. The type of insurance you purchase when you flip houses would definitely be different from the one you have for a straight rental. There is also higher risk of something that would go wrong. Operating within the protection of a corporation, a separate legal entity, definitely provide more protection from your personal assets.
From the tax perspective, the income is considered as active business income within the corporation and hence being taxed at 15.5% for the first $500,000 of net income. The taxpayer strategically renovates each house, actively looks for buyers and markets it for sale. This would be considered substantial evidence that the taxpayer is operating it as a business.
The profit the Montreal woman made would have been taxed at 15.5% at the corporation level. When she took money out from the corporation as dividend, she would be taxed at personal level. If she has no other income, the first $35K of dividend is tax free at her personal tax level. Combined tax rate at the best case scenario is 15.5%.
Alternatively, she can also keep the cash within the corporation. Meaning that she can use the 84.5% after tax money to reinvest and flip more properties.
However, the difference between operating a flipping business and holding investments is that the houses are considered as inventory in the first case. A taxpayer is not allowed to deduct Capital Cost Allowance to defer any rental income you would otherwise incur.
Unfortunately, there is no easy answer for everyone.
The Court looks at every taxpayer’s situation closely to make their final conclusion.
If your intention for conducting the transaction is an investment, speak to your professional advisor to properly document all the relevant evidence.
If your intention is to operate it as a business, speak to an expert to position yourself properly from both tax and legal perspective.
Until next time, happy real estate investing.
Cherry Chan, Your Real Estate Accountant