My client purchased a old home in March 2022 with the intention of fixing it up and flipping it. By November the real estate market had tanked and he panicked and decided to cut his losses and sell it. He sold the property for a loss. He had a $23k interest expense for the 9 months. As his intention was to flip the property, my approach is that the interest is on account of capital, not income and as such, the interest is not deductible. It would be added to the ACB along with the other soft costs (utilities, property tax) and increase his capital loss. I would just like to confirm my approach with the forum.
I would argue that as you state his INTENTION when he purchased the property was to sell for a profit. Therefore business income and expenses (also if the close date of the sale is after Dec 31, 2022 he falls under the new flipper rules anyway). So I would go and claim the business loss, way better than a capital loss.
Thanks @jimt. The new flipper rules apply to gains only, not losses unfortunately but the sale was in 2022 so definitely a capital loss. Yes his intention was to sell for a profit, never to earn rental or business income. Doesn’t that mean the interest expense is on account of capital?
If the intent was to flip the house, then the entire activity is on account of income.
However, I don’t believe individuals can’t claim business losses on flipped houses. I can’t find anything to back that up. I had experience as an associate long ago when a client was a sole proprietor house flipper, and they had a loss year. We had to report a $nil amount on his 2125 despite his loss of over $50,000.
Based on that experience, everything gets reported on the T2125, but the loss should be eliminated.
The interest is definitely on account of income since it was incurred to earn business income (flipping a house). If your client turned a profit, the interest would go against that profit.
A lot of these questions are hypothetical, so there is really, no way to answer, I guess that’s why we see lots of intents and questions of facts. You want it as business income because you can get the deduction instead of capital loss, and said it’s intent, but if previous years, you have been claiming capital gain, don’t see how you can justify the intent there
I just finished the personal tax update course with Video Tax news. I posed this question to the presenters and the answer I got back was:
“The new deeming provision does not apply to dispositions that would result in a loss. The standard foundational rules would apply.”
The problem is I don’t know what the standard foundational rules are. I can’t find anything that discusses losses although in today’s market with high interest rates and declining property values (Toronto) we might see it more.
The interest deductibility folio states that all interest is on account of capital unless a specific exception is met. The exceptions are “intent to earn income from business or property” and goes on to say a capital gain is not considered to have met this use test. That being said, if my client had a gain, it would have been considered business income because of the intention to flip. My client has no other business or investment income, only a T4.
@jeremy1 Are you suggesting that even the capital loss can be denied? Why do you say “we had to” ? Was there a specific ITA provision that you were following or was there CRA correspondence?
GST would had applied in the course of business activity, so if GST was paid in the first place, I guess it would be able to substantiate that. Some argued that GST doesn’t apply on used property, and again, I don’t think we have it both way, saying it’s used property, not inventory, for that purpose, and now, saying it’s inventory for interest deduction. Ancillary purpose might come into play, but I would assume, a deemed change in use, resulted in superficial loss, and added to the ACB, so end result would be the same
I am confident there would not be a capital loss in this case. The intention was to flip the house. That is a business activity, not a capital/investment activity.
Again, I can’t find a source for not being able to claim a business loss when you’re in the business of flipping houses, but it’s what the partner at my first job instructed me to do. I did find this post from GT that discusses the new flipping rules and states “individuals cannot report a business loss on a property just because it meets the definition of a flipped property.”
Flipped property — deemed business(12) For the purposes of this Act, if, absent this subsection and paragraph 40(2)(b), a taxpayer would have had a gain from the disposition of a flipped property, then throughout the period that the taxpayer owned the flipped property
(a) the taxpayer is deemed to carry on a business that is an adventure or concern in the nature of trade with respect to the flipped property;
(b) the flipped property is deemed to be inventory of the taxpayer’s business; and
(c) the flipped property is deemed not to be capital property of the taxpayer.
Marginal note:Definition of flipped property(13) For the purposes of subsections (12) and (14), a flipped property means a housing unit of a taxpayer (other than a property that would be inventory of the taxpayer if the definition inventory in subsection 248(1) were read without reference to subsection (12)) located in Canada that was owned by the taxpayer for less than 365 consecutive days prior to the disposition of the property, other than a disposition that can reasonably be considered to occur due to, or in anticipation of, one or more of the following events:
(a) the death of the taxpayer or a person related to the taxpayer;
(b) one or more persons related to the taxpayer becoming a member of the taxpayer’s household or the taxpayer becoming a member of the household of a related person;
(c) the breakdown of the marriage or common-law partnership of the taxpayer if the taxpayer has been living separate and apart from their spouse or common-law partner for at least 90 days prior to the disposition;
(d) a threat to the personal safety of the taxpayer or a related person;
(e) the taxpayer or a related person suffering from a serious illness or disability;
(f) an eligible relocation (as defined in subsection 248(1)) of the taxpayer or the taxpayer’s spouse or common-law partner, if that definition was read without reference to the requirements for the new work location and the new residence to be in Canada;
(g) an involuntary termination of the employment of the taxpayer or the taxpayer’s spouse or common-law partner;
Marginal note:Flipped property — loss denial(14) For the purposes of this Part, a taxpayer’s loss from a business in respect of a flipped property is deemed to be nil.
The word “business” is defined in subsection 248(1) so as to include, inter alia, an adventure or concern in the nature of trade. This definition can cause an isolated transaction involving real estate to be considered a business transaction. As a business, any gain or loss which arises therefrom is, by virtue of section 9, required to be included in computing income or loss, as the case may be.
There is no provision in the Income Tax Act which describes the circumstances in which gains from the sale of real estate are to be determined as being either income or capital. However, in making such determinations, the courts have considered factors such as those listed below: (The list is not intended to be exclusive of any other factor.)
(a) the taxpayer’s intention with respect to the real estate at the time of its purchase;
(b) feasibility of the taxpayer’s intention;
(c) geographical location and zoned use of the real estate acquired;
(d) extent to which intention carried out by the taxpayer;
(e) evidence that the taxpayer’s intention changed after purchase of the real estate;
(f) the nature of the business, profession, calling or trade of the taxpayer and associates;
(g) the extent to which borrowed money was used to finance the real estate acquisition and the terms of the financing, if any, arranged;
(h) the length of time throughout which the real estate was held by the taxpayer;
(i) the existence of persons other than the taxpayer who share interests in the real estate;
(j) the nature of the occupation of the other persons referred to in (i) above as well as their stated intentions and courses of conduct;
(k) factors which motivated the sale of the real estate;
(l) evidence that the taxpayer and/or associates had dealt extensively in real estate.
None of the factors listed in 3 above is conclusive in itself for the purpose of determining that a gain arising on the sale of real estate constitutes income or a capital gain. The relevance of any factor to such a determination will vary with the facts of each case.
@jyliucpa nevermind! I found it under ss. ITA 12(14).
@Versa, the legislation under subsections ITA 12(12) - ITA 12(14) pertains to income inclusions (and loss denials) for house flipping. Also, IT-218R that @Rein posted if valuable information to ensure correct treatment for your client’s situation.