Assignment of a Right to a Property and the Tax Implications That Follow Part 2

Assignment Sale In the first part of this article, we discussed how the CRA may view an assigned property, specifically the possibility that they may view the assignor of a property as a builder, and examined the related HST implications that follow. The article can be found here. If you have not already done so, I encourage you to read part 1 as it provides valuable information that could save you money along with insightful examples which we will reprise in this article. In part 2, I will be discussing the income tax implications for someone who assigns a property. Upon assigning a property, an individual is required to report the profit as income on their T1 in the following year when they file their taxes. But what kind of income should the sale be reported as? Most simply assume the profits from the sale will be considered capital gain income by the CRA, subsequently requiring taxes to be applied for just half of the profit. This presumption, however, does not always hold true. It is possible for the CRA to deem the income to be fully taxable business income. There is no specific provision subsumed within the income Tax Act outlining the circumstances in which the proceeds from a sale of property are to be reported as capital or business income. The courts have historically considered several factors in making such a determination. Some of the primary factors considered are listed below and can also be found, with greater detail, on the CRA website here. These factors include:

  1. Individuals’ stated or deduced intention with respect to the property at the time of purchase.
  2. The feasibility of said intention.
  3. Geographical location and zoned use of the property that was acquired.
  4. The extent to which this intention was carried out by the individual.
  5. Nature of the business/profession the individual is involved in.
  6. The extent to which borrowed money was used to finance the real estate acquisition, including the terms of the financing.
  7. The length of time the property was held by the individual.
  8. If there are other individuals who shared an interest in the property.
  9. The occupation of other individuals who shared an interest in the property as well as their intentions and courses of conduct.
  10. The factors involved in the sale of the property.
  11. Evidence that the individual and/or their associates have previously dealt with real estate.

Taken together, these factors will be used to influence the CRA in making a determination on whether a sale of a property will be considered as business income or capital gains. Let’s revisit the examples from part 1 of this article using the factors listed above to determine what type of income the CRA would likely consider the proceeds of the sale to be counted as.  Example 1Assignment of property Bob and Natasha own a 3-bedroom house where they live with their two children. In May 2010, they entered into a purchase and sale agreement with a builder to buy a single bedroom condo. The purchase price was $310,000 with a closing date in November 2011. In June 2011, while the property was still under construction, they assigned the right to their property for $350,000. Let’s add the additional assumption that each of them earns $50,000 annually. If the CRA could prove that Bob and Natasha likely couldn’t afford the condo when it closed, that may be used as to determine their intent was to turn a profit. In this case, assuming there wasn’t any money borrowed, and any down payments made along the way were made from a short-term form of financing, like a Line of Credit for instance, that could tilt the scales in favour of speculative intent. After all, $100,000 combined gross income with 2 children and a 3 bedroom house to tend to would make it difficult to afford an investment property at $310,000. Further evidence to be considered would be their occupations. If Bob or Natasha were real estate agents, that would certainly be a strike against them. Even if none of the above factors provided strong enough evidence to consider the sale as business income, the CRA could still refer to IT Bulletin 459titled “Adventure or Concern in the Nature of Trade”. In this bulletin, point 2 states that when a sale of a property is done infrequently, or possible only once, rather than habitually, it still is possible to hold that the person has engaged in a business transaction if, in accordance with the definition of “business” in subsection 248 (1), it can be show that he has engaged in “and adventure or concern in the nature of trade”. In general, it means the CRA will carefully examine the taxpayer’s conduct, the nature of the property and taxpayers intentions with respect to the property in determining if the assignor is engaging in the business of speculating on the property for profit, even if doing so is not a common form of behaviour on the part of the assignor. For more details, you can view CRA IT Bulletin 459 here.  If the profits are found to be a capital gain, and assuming from part 1 of this article that they are deemed builders by the CRA and forced to remit HST on the profit, the taxes payable are as follows:

Purchase price $310,000
Assignment $350,000
Profit $40,000
HST $4,600
Net Profit $35,400
Capital Gain $17,700

Taxable Capital gain for each (assuming the property is in both of their names) would be $8,850 with an income tax payable of $2,743.50 each (tax rate of 31% based on their marginal tax rate). Therefore, as a capital gain, they are left with just under $30,000 after HST and income tax. Let’s see how this compares to the case where profits are ruled as business income.In this situation, the full net profit of $35,400 (or $17,700 apiece) would be taxed at their marginal rate of 31% for a total tax payable of $10,947. They are now only left with just under $24,500. The difference is considerable and becomes more substantial the higher the marginal tax rate. Example 2 Nelson and Eva rent a 3-bedroom house where they live with their two children in Toronto. After learning that Eva is pregnant with their third child, they felt their rented unit was too small to accommodate their burgeoning family. They enter into a purchase and sale agreement with a builder in February of 2012 to buy a new 4-bedroom house, set to be completed in May of 2013 for $450,000. In January 2013, Nelson was promoted with a substantial raise and his new position required him to move to Ottawa. As a result, the family assigned the 4-bedroom property for $500,000. In Ottawa they purchased a 4-bedroom property to live in. Assume both their incomes are $100,000 annually. In this situation it is likely that Nelson and Eva will be allowed to report the proceeds as a taxable capital gain since the nature of their circumstance seem to indicate they had no choice but to sell the property, and that the sale came about by unforeseen events. So long as other factors, like the ones explained above, don’t strongly conflict with this presumption, the ruling is straightforward. In this case, as was explained in article 1, we also note that HST would not apply. The calculation is as follows:

Purchase price $450,000
Assignment $500,000
Profit $50,000
Net Profit $50,000
Capital Gain $25,000

With a taxable Capital gain of $12,500 each, and a tax payable of $5,425 a piece (tax rate of 43.4% based on their marginal tax rate) they are left with $39,150 after-tax profit. For the sake of comparison, had the gain been treated as business income instead, the after-tax profit would plummet to $28,300. Disclaimer: The information contained herein is not meant to be professional advice but for educational purposes only. You should consult with your accountant when handling such matters.

Assignment of a Right to a Property and the Tax Implications That Follow Part 1

Assignment

With the strength of the preconstruction market over the past decade, many have chosen to reap the benefits by purchasing property on plan from a builder and subsequently selling the rights to the property, with a markup, to another buyer before closing. Selling a construction property prior to closing is formally known as an assignment of a property. Not all assignments are done strictly for profit; there are situations that may arise requiring a purchaser to assign a property originally intended to be a principal residence. Most builders allow assignments to be done at little to no charge. However, it’s important for anybody considering assigning a property to be aware of the nuances involved. In particular, what are the potential HST implications on the sale of the right? How should any potential markup earned on an assignment be reported; as a capital gain or business income? The latter will be discussed in the second of this two-part blog; here I will first discuss HST considerations.

To answer the HST question, it will depend on the determination of the primary purpose of the property from the point-of-view of the CRA. Namely, was the property purchased with the intent of reselling at a markup, or was it originally purchased as a primary residence only to have extenuating circumstances require the assignment? If the intended purpose of the property is concluded to have been to resell for profit, the CRA could define the assignor of said property as a “builder” for HST purposes, even if the assignor is simply a buyer and not actively involved in the construction process. Furthermore, if the assignor is ultimately deemed a builder by the CRA, they are subsequently required to charge and remit HST on the markup earned from the assignment. The CRA will take various factors into consideration in ascertaining the intended purpose of a property and whether the title of “builder” should be transferred to an assignor. Some of the primary factors considered by the CRA can be found in the GST info sheet GI-120 here.

They include, but aren’t limited to:

  • The person offers to sell his/her interest in the property or explores other avenues to sell the property before or while the house is under construction.
  • The financing of the property indicates that it’s for short-term usage. The mortgage is short-term and could be paid off without penalties rather than a long-term or closed mortgage.
  • The financing of the property is unreasonable for the person given their income level, making it appear that the person is relying on the increased value of the property to resell the house.
  • The person’s stated interest is to occupy the property as their primary residence, but their personal circumstances make such a claim appear dubious.
  • It appears that, based on the person’s pattern of activity, their occupancy of the property does not have the characteristics of a permanent one.

There are other considerations as described in GST/HST Memorandum 19.2 that can be used to determine if an assignor may be considered a builder, but those summarized above are most commonly used to identify a builder. Allow me to illuminate the point with a couple of examples.

Example 1

Bob and Natasha own a 3-bedroom house where they live with their two children. In May 2010, they entered into a purchase and sale agreement with a builder to buy a single bedroom condo. The purchase price was $310,000 with a closing date in November 2011. In June 2011, while the property was still under construction, they assigned the right to their property for $350,000.

Point four listed above may be used to determine that Bob and Natasha be deemed builders in this case and be forced to charge HST on any markup earned from their assignment of the one bedroom condo. Even if they have no prior history of buying and selling real estate, it would not have made sense for a family of four to leave a 3-bedroom dwelling in favour of a one bedroom condo. Based on the available information, it appears likely that their primary purpose in acquiring and selling the property before closing was to sell the condo unit at a profit.

Example 2Family Home

Nelson and Eva rent a 3-bedroom house where they live with their two children in Toronto. After learning that Eva is pregnant with their third child, they felt their rented unit was too small to accommodate their burgeoning family. They enter into a purchase and sale agreement with a builder in February of 2012 to buy a new 4-bedroom house, set to be completed in May of 2013 for $450,000.
In January 2013, Nelson was promoted with a substantial raise and his new position required him to move to Ottawa. As a result, the family assigned the 4-bedroom property for $500,000. In Ottawa they purchased a 4-bedroom property to live in.

In this instance, it’s clear that the assignment of the right to the property was a result of work relocation and that the primary purpose was not to resell interest of the house for profit. Nelson and Eva would likely not be considered builders in this case and thus would not be required to charge HST.

In the event that a buyer was deemed a builder by the CRA, what would this entail? Using the numbers in example 1, the property was purchased for $310,000 and assigned for $350,000. The assignor would have to assign the property for the extra $40,000 in gain plus 13% HST ($5,200). Assignors often fail to charge additional HST, thus rendering the $40,000 profit as being inclusive of HST, requiring the lawyer to remit an HST amount of $4,600 to the CRA, cutting the take-home profit to $35,400.

From the point of view of the assignee, they would then be eligible to benefit from the HST rebate on a newly constructed property on the extra $4,600 remitted. Generally, the HST rebate is applied for by the builder on behalf of the buyer and factored into the final price. Thus, the original $310,000 price paid by the assignor when the price was first agreed upon with the builder had already factored in the rebate due to be received after closing. Here’s the breakdown of the original $310,000 purchase price:

The breakdown of a $310,000 purchase price in Ontario is as follows:

$294,677 Actual price
+$14,734 GST (5%)
+$23,574 PT (8%)
-$5,304 (GST rebate: 36% of GST)
-$17,681 (PT rebate: 75% of PT)

Had the builder not factored in the rebate, the original purchase price would have been $22,985 higher. Since the CRA only allows one HST claimant on the property, it is in the best interest of the assignee to pay the total price of the property, inclusive of all tax, and then apply for the full rebate themselves. Thus, the purchase price for the assignee would total $372,985 ($350,000+$22,985 original rebate). Not only would the assignee receive the $22,985 original rebate back, they would also get an additional rebate of $2,761 due from the extra $4,600 HST paid on the $40,000 markup. The breakdown of this additional rebate is as follows:

The GST of $1,770 yields a rebate amount of $637 (36%)
The PT of $2,832 yields a rebate amount of $2,124 (75%)
Thus, the extra $4,600 HST would yield a refund of $2,761, resulting in a final price to the assignee of $347,239.

The rebates available on the federal and provincial portion of the HST are not always straightforward. If you are unfamiliar with the calculation of an HST rebate on newly constructed properties, like the one demonstrated above, I invite you to read my HST rebate blog here.

Watch for part 2 of this article where I will discuss the effects on income tax for an assignor.

Disclaimer: The information contained herein is not meant to be professional advice but for educational purposes only. You should consult with your accountant when handling such matters.