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November 19, 2018 | Tax Cops Cometh

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

It’s estimated six in ten homeowners in Vancouver have a suite in the basement occupied by a blinking, mole-like creature called a ‘tenant’ who probably has a bike and votes NDP. Some of these apartments are legal, with the owners deducting expenses and declaring the rent as taxable income. A motherlode are not. And the CRA has one of their famous ‘projects’ ongoing to sniff them out.

Actually the revenuers have been in overdrive recently, moving into Van and the GTA to sift through the remnants of the property bubble and Hoover up their share of the windfall profits. These guys are now opening about 250 new files each and every week, looking primarily for condo flippers. In the last three years the feds have siphoned off $650 million in taxes and fines from people who bought and sold units in pre-con buildings or acquired and dumped houses for a profit, trying to claim an exemption or a capital gain.

All this will get more interesting after Christmas when income taxes are filed, now that all residential real estate transactions have to be reported, detailed and (if you are asked) proven. As this pathetic blog pointed out two years ago when it became necessary to apply for a capital gains exemption on residential real estate (instead of  being assumed, as before), the first step was taken in taxing homes. That is to establish a federal CRA property registry – matching addresses with owners, sellers, buyers and transactional details. In a few years you will see where this leads. It won’t be pretty.

Meanwhile the biggest guns are being leveled at those who bought unbuilt condos then sold them as assignments. That’s perfectly legal, but many have tried to escape tax by saying they intended to live there (so it was really a principal residence), or claim the profit as a capital gain subject only to 50% tax. Of course, the feds don’t see it that way. To them it’s income. The profit must be added to your regular pay and taxed 100% at your marginal rate.

Ditto for flippers, those who bought a home during the FOMO frenzy, then sold it again for more a few months later. It even applies to DIY dudes and amateur contractors who buy properties, live through a reno, then list. The CRA says this is a business activity and the income generated (above expenses) should be taxed as such. Worse, if you try to avoid declaring this money it’s possible you could face a further 50% penalty for gross negligence. Ouch.

Now, about renting your basement…

First understand what a PR is. To qualify as a principal residence and pay zero tax on the money you make selling it, the property (owned or leased) must be inhabited by you, your squeeze or your kids for a portion of the year. If it’s with listed with the CRA, on your driver’s license and health card, there’s no issue. Yes, you can try claiming the cottage while living in the city, but don’t be surprised if you’re challenged. And remember if you claim a secondary property as PR in order to escape tax, you’ll be eliminating your primary property at the same time.

Here’s a redneck alert: the PR status only applies to your house and about 1.2 acres (or half a hectare). The rest of the property will not qualify for tax-free status in the event of a sale. The goats are on their own.

Now, back to renting. Whether your basement is legal with the city or not, you still have to deal with the CRA. If you collect rent, Ottawa expects you to declare it and pay tax – but you can deduct expenses, including a portion of the mortgage payment, utilities and fumigators. The real question is whether or not renting out some space alters the tax-free status of your home.

The answer is no, if (a) the area rented is a small part of your overall property, (b) you alter nothing in order to create a rental space and (c) you don’t claim depreciation.

However, if you created a rental suite by adding a door to the basement, erecting a stair case to a rental apartment, putting in a new bathroom or even a shower in an existing bath, or throwing up some drywall to separate the suite, then – bingo – everything changes.

In that case the part of the property which is rented will be deemed to have been disposed of. In the eyes of the tax cops you sold at fair market value and bought back the same day. Thus you’ve reduced the overall future capital gains tax exemption by a significant amount so when you sell, a portion of the profit will be, in fact, taxable.

At that time you’ll have to split the selling price between the PR amount and the taxable portion. “We will accept a split based on square metres or the number of rooms as long as the split is reasonable,” says the CRA. On the non-PR portion capital gains will need to be reported, while the rest stays at zero.

Now, think about a Van house that’s escalated wildly over the past decade. By carving out a basement suite or a laneway house, and reducing the PR exemption by 30% or 40% you could be making a life-altering windfall taxable, at least in part. Chances are the (taxable) rent collected from the moldy beings in the cellar would never compensate for the new tax hit.

Moral: keep the fruit cellar for fruit.

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November 19th, 2018

Posted In: The Greater Fool

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