In general, gains are fully taxable where the taxpayer buys a property with the intention to sell for a profit (sold on “account of income”). In other cases, half the gain is taxable (sold on “account of capital”). When a sale on “account of capital” involves the sale of a principal residence, the tax may be reduced or eliminated by using the principal residence exemption.
In a December 13, 2019 French Tax Court of Canada case, at issue was whether two apartment buildings sold by the taxpayer were on account of capital (as filed by the taxpayer) or income (as assessed by CRA).
After acquiring the two apartment buildings, the taxpayer paid the tenants to voluntarily vacate their leases. The buildings were then renovated and sold for a profit. The taxpayer argued that it was only after the discovery of fundamental structural problems with the properties that the original plan to rent the units changed, and that the taxpayer decided to resell both buildings.
The Court did not accept the taxpayer’s argument that the corporation did not have the funds to finance the renovations required due to the substantial structural problems, as it paid large amounts to the tenants to vacate the property. Also, it concluded that it was highly improbable that, at the time of acquisition, the taxpayer was not aware of the extent of the problems affecting the properties.
The following factors were also considered to indicate the property was acquired for resale:
- the period of ownership (up to 18 months) was very short;
- the director of the corporation was an experienced real estate businessman, indicating that he would likely have known he could make a profit by buying and selling the buildings quickly;
- the buildings were located in a popular and highly sought-after area of Montreal; and
- one of the buildings was funded fully by debt, with the other largely financed by debt. A portion of the purchase price was not due until a number of months after sale.
The Court ruled that, on the balance of probabilities, the intention of the taxpayer was to resell the properties at a profit. The sale was therefore on account of income and fully taxable.
ACTION ITEMS: Retain documentation, (emails, letters etc.), which occurred at or around the time of purchase to support your position as to whether the property was acquired on account of income or capital.