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Evidence of the ongoing crackdown by the tax authorities on Canada’s red hot residential real estate sector is everywhere, from recently updated statistics that show increased real estate audit activities, to new rules governing the sale and reporting of your principal residence and even some recent tax cases.

Earlier this year, the Canada Revenue Agency indicated that transactions in the Greater Toronto Area have been the subject of greater scrutiny, including audits, for some years and that, more recently, the CRA has been actively monitoring and auditing real estate transactions in British Columbia. The CRA is focused on a number of areas of compliance risk in the real estate sector, which include: questionable sources of funds, property flipping, unreported GST/HST on the sale of new or substantially renovated properties, the new housing rebate and unreported capital gains.

Since April 2015 to the end of September 2016, the CRA indicated that in Ontario it has completed the audit of 13,403 files resulting in a recovery of $210.4 million. In B.C., during the same period, the CRA audited 2,366 files, resulting in $30.3 million in recovered tax. The CRA also charges a penalty equal to 50 per cent of the additional tax payable if a taxpayer knowingly makes a false statement when filing a return. During this period of increased audit activity, the CRA applied 663 penalties, totalling $12.5 million, with the highest single penalty being nearly $2.5 million.

Last month, in an effort to gather data about the dispositions of principal residences, the CRA reversed its long-standing published administrative policy that said you did not have to report the sale of your principal residence on your tax return if you were eligible for the principal residence exemption. Starting this year, the CRA said that it will only allow the PRE if you report the sale and designation of principal residence on Schedule 3, Capital Gains of your return.

The CRA is also pursuing, and winning, tax cases against individuals involved in real estate transactions. Take, for example, the most recent case, decided earlier this month involving the GST/HST new housing rebate, which allows an individual to recover some of the GST or the federal part of the HST paid for a new or substantially renovated house.

One of the main conditions to be eligible for the new housing rebate is that you must buy or build the house for use as your or your relative’s primary place of residence. In addition, if the intention at the outset is to flip the property, you won’t be eligible for the rebate.

The recent case involved an Ontario couple that attempted to claim an HST new housing rebate for a house they purchased in Milton. The purchase agreement was dated in October 2011 for a price of about $425,000. The purchase of the house closed on April 10, 2013 and it was immediately listed for resale on April 21, 2013 for $517,000 as a “Brand New Never Lived in Home.” The house sold shortly thereafter for about $510,000.

The CRA denied the couple’s claim on the basis that the couple never lived in the home when they bought it nor did they ever intend to based on the location of the house relative to where they then lived and worked and relative to where they later bought a different type and size and value of house into which they did move.

The couple argued in tax court that when their “financial and employment circumstances ... changed, they decided they had to sell the new house by the time it was built but that her mother-in-law had moved into the house in the interim.” A relative living in the home would have satisfied the condition for the rebate.

Both the CRA and, ultimately, the judge had serious doubts that the mother-in-law ever moved in since both the house’s listing and the advertising refer “in unqualified terms to the fact that the house was brand new and never lived in.” As the judge wrote, “It is hard to imagine how the presence of someone living in the house could not be apparent to prospective buyers looking at a brand new never-lived-in home. It is equally hard to imagine a realtor taking such a risk.”

The judge reviewed the home’s utility bills for the short period of ownership. The gas bill showed an almost immaterial gas consumption, and the hydroelectric and water bills showed minimal amounts of electricity used and “0.00 cubic meters of daily water use.”

As a result, the judge denied the couple’s claim for the HST new housing rebate. He also pointed out that this was consistent with the CRA’s assessment of tax on the gain on the sale of the house, as opposed to a tax-free gain as a result of claiming the principal residence exemption.

Originally Posted in Financial Post