When disposing of a property, it is essential to determine the nature of the income or loss arising from the transaction from a tax point of view. Profit can be taxed as a capital gain or as business income, with very different tax consequences.
Qualification depends on the circumstances, and is not always straightforward. To help you see things more clearly, we’ve summarized the main points to consider. You’ll also find a summary of the new rules on precipitous resales of residential real estate that came into effect on January 1, 2023.
If you have rental income or are planning to sell a property in the U.S., read on for our specific article on this topic.
Tax classification of income from the sale of real estate: business income or capital gain?
The importance of properly qualifying the transaction
Capital gains treatment allows only 50% of income to be taxed, even going so far as to exempt all income from tax in certain cases, if the principal residence exemption applies. If the transaction gives rise to business income instead, this exemption is not available and the income must be taxed in full.
Each transaction will have to be assessed on its own merits. In addition, its treatment will depend on whether the asset sold is classified as an inventory item or as a fixed asset. Several factors, such as the taxpayer’s intention, the length of time the property has been held, and the number and frequency of transactions, will have to be taken into consideration, but none of them is decisive. It is therefore possible for a transaction to give rise to business income, even if the property is held for several years, or if it is the taxpayer’s first real estate transaction.
Furthermore, in its 2022-2023 federal budget, the federal government announced its intention to introduce a measure that will automatically qualify income from the sale of residential real estate held for less than 12 months as business income. Real estate flips” are specifically targeted. However, there are a few exceptions, as explained below. On June 9, the Quebec government announced that Quebec’s tax rules in this area would be harmonized with the new federal rules.
We always recommend that you evaluate the specific facts of your transaction with one of our real estate tax specialists. An accurate analysis of your situation will reduce the risk of your transaction being characterized differently by the tax authorities.
New rules announced for precipitous resales of residential properties
Notwithstanding the general analysis criteria described in the following section, to the extent that a person resells a residential property, including a rental property, within less than 12 months of its acquisition, the income from the sale will be deemed to be business income. It will then not be possible to claim the principal residence exemption. This measure should apply to dispositions taking place on or after January 1, 2023, at both federal and provincial levels.
Nevertheless, exceptions will be made to take into account circumstances that may require an individual to resell his or her property more quickly than expected. Among these, the following events were immediately announced as exceptions to the new presumption:
- Death of the taxpayer or a related person;
- Addition to the household, in particular due to the arrival of a child or the care of certain family members at home;
- Separation of spouses for more than 90 days due to relationship breakdown;
- Personal safety, particularly in relation to domestic violence;
- Incapacity or illness;
- Change of job, if this is the result of an involuntary situation and the new home allows the taxpayer or his or her spouse to move at least 40 kilometers closer to his or her new place of work;
- Insolvency or provision to avoid it;
- Involuntary disposal of the residence, particularly in connection with expropriation or destruction of the residence.
A precise list of exceptions to this rule has not yet been defined, however, and will be the subject of public consultation.
General analysis criteria
The courts have developed a multi-criteria analysis structure to determine income qualification. Each of them must be applied to each situation. In the case of real estate transactions, special factors are regularly taken into account.
The table below summarizes the impact of the various analytical criteria on the characterization of income from the sale of real estate, as observed in case law.
It should be noted that the criterion whose analysis is generally the most decisive is that of intention, both primary and secondary. If there is clear evidence of the taxpayer’s intention in acquiring the property, this is likely to be decisive, and is often the central element in a court’s decision. A change of intention during the ownership period may also alter the qualification and give rise to different taxation from that date, for example in the case of subdivision of rental units for resale purposes.
| Summary of the impact of the main analysis criteria on income qualification | ||
| Trend towards capital gains | Trend towards business income | |
| The main intention | Evidence that the property was acquired as a capital asset, in particular for rental purposes or to carry on a business or to live in. | Evidence that the property was acquired for resale at a profit |
| Secondary intention | No evidence that there was also a second intention at the time of purchase to acquire the property for resale should certain circumstances arise | Evidence that there was also a second intention at the time of purchase to acquire the property for resale should certain circumstances arise |
| Circumstances surrounding the disposition | Unsolicited sale or sale precipitated by unforeseen circumstances | Active steps to sell the building |
| Sales efforts | No special steps to maximize gain on sale | Work or steps taken to sell the property and/or increase its sale value |
| Detention period | Long-term | Short-term |
| Number and frequency of transactions | Low number and frequency | High number and frequency of property flips |
| The relationship of the transaction to the taxpayer’s activities | No other real estate or business-related activities | People involved in real estate or business-related activities, such as building inspectors, real estate agents, construction workers, accountants, contractors, etc. |
| The nature of the transaction and the property | Capital or income-producing asset | Inventory or non-income property |
| Geographical location and zoning of the property purchased | Zoning and location consistent with activities claimed to have been planned for the asset | Zoning and location not in keeping with activities claimed to have been planned for the asset |
| Financing arrangements | No specific financing arrangements | Flexible and favorable financing terms / Consecutive sales of buildings where proceeds are reinvested in successive new buildings |
| The fact that possession of the property is shared with others | The analysis of the above-mentioned criteria carried out for other persons tends to qualify them as capital gains. | An analysis of the above criteria for other people tends to qualify them as business income. |
It’s important to remember, however, that each transaction is unique. While these criteria can be used to determine the qualification of a transaction, the fact remains that for some transactions, the criteria analysis is split between business income and capital gain. There are therefore risks associated with qualification, and its nature cannot be predetermined with absolute certainty.
Our team of tax experts is ready to help you determine the nature of the income from the sale of your property, whether it’s your principal residence, rental properties or “real estate flips”. Please contact us to discuss your situation and whether your sale qualifies as business income or capital gain.
Article written by Caroline Poulin, LL.M. Fiscal authorities. Canadian tax lawyer in collaboration with Jean-Philippe Binette CPA, LL. Mr. Fisc.
