Tax Traps for Individuals Acquiring Unbuilt Residential Condominium Units

November 2016 The scenario A single young man (call him John) working in downtown Toronto is looking for a small condominium unit that will allow him to walk to work in the morning and enjoy nightlife in the evening. John visits a sales office for an unbuilt condominium project that seems to address his wish list although he’s a bit concerned about buying “on paper”. The sales agent assures him the building will be ready for occupancy in 12 to 18 months. John signs the purchase and sale agreement but years later is still waiting for construction to be completed. In those intervening years, John has worked hard, gotten a few raises, met his soul mate and is ready to settle down and start a family in the suburbs. That 600 square foot condominium in the party district of downtown Toronto is no longer part of his plan. John sells his interest to a third party (call her Jane) and pockets a nice profit. This type of transaction is referred to as an “assignment” of a purchase and sale agreement. While completing his tax return the following spring, John wonders how or if he reports the profit on his tax return. He listens to a friend who tells him he doesn’t have to report anything because principal residence transactions are tax-free in Canada. A year or so later, a letter arrives in the mail. CRA is reviewing the assignment of his interest to Jane. Is John’s profit eligible for the principal residence exemption? No. The principal residence exemption requires the property in question to have been (i) owned by John and (ii) ordinarily occupied as a place of residence. Because John neither owned nor lived in the property, his profit does not qualify for the principal residence exemption. Should John’s profit be taxed as a capital gain or business income? Law and jurisprudence would conclude that John is not a speculator and his profit should therefore be taxed as a capital gain with only 50% included in income. However, CRA is often denying capital gains treatment to persons like John and instead treating the profit as fully taxable business income. CRA is also assessing for failure to collect HST on the assignment proceeds because HST applies if one’s primary intention for acquiring the interest was to resell the interest prior to close. It can be a challenge to prove intention to CRA since there is seldom any documentation evidencing one’s thought process when searching for a new home.

What if John had lived in the unit before selling? The occupancy date for a newly constructed condominium unit is seldom the date a purchaser acquires legal ownership of the unit. Generally, a purchaser will enter into a temporary occupancy agreement with the builder to be allowed to live in the unit as a quasi-tenant until such time as the building is registered as a condominium under the relevant provincial legislation. The builder cannot sell the unit until the building is registered as a condominium and registration is usually several months after the occupancy commences. If John sold his interest after moving in but before the condominium was registered, John would be denied the principal residence exemption because he did not yet own the property. CRA’s position is that a condominium unit is not owned until the condominium is registered and the purchase transaction has closed. If John lived in his unit long enough for the condominium to be registered and took legal ownership before selling, the outcome with CRA remains unclear. Under this scenario, John did own the unit which means he satisfied one of the principal residence tests. However, he would still need to show that he “ordinarily inhabited” the unit as his place of residence. There seems to be a widely held belief that the principal residence exemption requires a 6 month de minimus occupancy period. There is no such rule. The determination of whether John ordinarily inhabited the unit is based solely on the facts. CRA will look at a variety of factors that may seem banal but are critically important when a principal residence claim is under audit. John had to do a lot more than put a few dishes in the cupboards and a jar of mustard in the fridge. Did he change his address on his driver’s license, file a change of address notification with Canada Post, advise his bank and credit card companies, update his employee benefit plan records at work? Were his utility and phone bills mailed to his new address? Were internet and cable installed? Does he have any personal letters sent to him at the new address? Did he advise CRA of his new home address? Does he have pictures of personal activities going on in the residence, such as birthday parties, a house warming party, and so forth? Did he join any condominium resident groups? Does he have anything on social media telling friends about his new home? Can he show evidence of the move, such as an invoice for a truck rental? CRA is going so far as to compare the amount of electricity usage by questionable claimants to average usage for comparable occupied units (yes, this sort of information is actually available). How did CRA find John? The assignment of a purchase and sale agreement for an unbuilt condominium is not recorded at the provincial land registry because the transaction is not a conveyance of real property. The builder however must consent to an assignment because the purchase and sale documents need to be revised to reflect a new purchaser. CRA is apparently going through builders’ records to identify parties involved in assignments of purchase and sale agreements.

Closing comments In many cases, CRA appears to be relying on hindsight to conclude that an individual’s intention from the outset was to profit from a flip of the interest. While there is no question speculators are present in many real estate transactions today, our experience indicates most assignments of purchase and sale agreements involve individuals like John whose life situation simply changed while waiting years for a condominium to be built. In our view, CRA has not been making a meaningful effort to distinguish between speculators and individuals like John. The resulting reassessments have led to an overwhelming number of objections filed with CRA Appeals Division. Individuals like John are now routinely waiting up to two years to resolve these issues with CRA. About the author Glen MacMillan is a tax partner at Adams & Miles LLP located in Toronto, Canada. Adams & Miles LLP

has one of the largest condominium practices in Canada. Glen is a founding member of the AGN

International Tax Committee and an active contributor to AGN knowledge share groups.