Flip with Care: Watch Out for Principal Residence Rules

There’s nothing like a good house flipping show to get you thinking about the cash potential in your own home. The house flipper approach is to buy homes, live in them short-term while fixing them up, and then sell them; often for big profits. It sounds simple, but it’s not a foolproof strategy, because it comes with tax risks. When done often, house flipping can raise eyebrows at the CRA. Learn how to flip with care, and understand the principal residence rules that could diminish your profits, or worse.

Though the housing market has recently cooled somewhat, the deposition of real property still has the potential to be very lucrative. This is especially true if you earn one tax-exempt capital gain after another using your principle residence exemption. But it’s not a claim that’s guaranteed – there are, in fact many grey areas in the burden of proof all taxpayers have in their relationship with the CRA. It’s important to understand these ahead of tax filing season. 

In the case of the sale of your principle residence, the CRA looks at your intention at the time you purchase the home as well as how many times you made similar transactions. If you buy and sell real estate too often, the CRA may disallow your claim for the principal residence exemption. Even worse, they could disallow the capital gains treatment that comes with a 50% inclusion rate. This circumstance requires the reporting of 100% of the gain as a gross profit if they get the impression you’re in the business of buying and selling homes. 

So where is the line drawn that determines whether profits are tax-free or classified as business income? The more closely your business or occupation is related to commercial real estate transactions (i.e. if you are a real estate broker or builder), the more likely it is that any gain realized from such a transaction will not qualify for the principal residence exemption at all and be considered business income rather than a capital gain.

The courts have considered some of the following criteria on a case-by-case basis to guide us in assessing the right tax filing requirements.   

Checklist for Determining Tax Attributes of Real Estate Dispositions:

  • The taxpayer’s intention with respect to the real estate at the time of its purchase
  • Feasibility of the taxpayer’s intention
  • Geographical location and zoned use of the real estate acquired, extent to which these intentions were carried out by the taxpayer
  • Evidence that the taxpayer’s intention changed after purchase of the real estate
  • The nature of the business, profession, calling or trade of the taxpayer and associates
  • The extent to which borrowed money was used to finance the real estate acquisition and the terms of the financing (if any) arranged
  • The length of time the real estate was held by the taxpayer
  • Factors which motivated the sale of the real estate
  • Evidence that the taxpayer and/or associates had dealt extensively in real estate

Your principal residence can be a great source of wealth, especially if you can use the principal residence exemption to pocket tax free accrued gains. But a warning to potential house flippers – know the tax rules. Your principal residence exemption may be at risk if you don’t follow proper tax filing procedures. And keep this important tax fact in mind: all principal residence dispositions, whether tax exempt or not, must be reported on your personal tax return.   

Excerpted from Essential Tax Facts by Evelyn Jacks, 2018 edition. The new 2019 version is available for pre-order by calling 1.866.953.4769 now.

Don’t Miss the RRSP Contribution Deadline: March 1.

The CRA officially began accepting electronically filed tax returns this week, but you may want to slow down and observe an important tax savings opportunity before you rush to file. Contributions to your Registered Retirement Savings Plan (RRSP) for the 2018 tax year ends on March 1, 2019. Besides reducing your tax bill, you could score even bigger returns: increased refundable and non-refundable tax credits.

To contribute, you have to have contribution room, which you can calculate yourself. Earned income includes employment income, net income from a proprietorship or rental property, net research grants, disability amounts received from the Canada Pension Plan and taxable support payments received. Or you can find your contribution room on your 2018 Notice of Assessment.

Keen savers can get a head start on their 2019 RRSP now. Your 2019 maximum contribution amount is 18% of your earned income in 2018 to a dollar maximum of $26,500. Plus, any unused contribution room carried forward from 2018. The $26,500 amount is reached when 2018 earned income hits $147,222. 

Your contribution room is also reduced by your Pension Adjustment (PA); which is generated if your employer contributes to a Registered Pension Plan or Deferred Profit Sharing Plan for you. Your contribution room may also be reduced by any Past Service Pension Adjustment (PSPA). If you leave your employment and have a Pension Adjustment Reversal (PAR), your RRSP room will be increased.

As you build RRSP contribution room, any amounts that are unfunded from prior years are carried forward throughout your lifetime for use in the future so long as you are eligible to contribute to your own or your spouse’s RRSP. By the end of the year in which you turn age 71, your RRSP must be converted to a RRIF (Registered Retirement Income Fund) or an annuity, and you can no longer make contributions. 

But, unused RRSP room can still be used to your advantage even if you are age ineligible. If you have a younger spouse, you can make Spousal RRSP contributions (a contribution to a plan under which the spouse is the annuitant) and still claim the deduction on your tax return so long as the spouse is age eligible.

Your next step is to see your tax or financial advisors to help you calculate and contribute to your RRSP in the most advantageous manner.

Thought Leadership: Five Tips on Building Team Culture

For many organizations – especially those in the tax and financial services – now is the time to build team culture in advance of a busy season of client interaction. Success of the team depends on so many factors including the right skills, processes and evaluation. For leaders of the team, there are five essential steps to building team culture in good times and bad.

So just how do you build a team culture that accomplishes maximum participation towards a single vision for success and common goals, especially in times of great stress?

Here are the five steps, as discussed in Knowledge Bureau’s new certificate course,  Business Leadership, Culture, and Continuity  which is found in the MFA-Executive Business Growth Specialist program:  

  • Establish your leadership – This refers to your own role as the founder, leader and master keeper of the vision. Before you can start building an effective team, you need to develop the right kind of leadership skills yourself. This does not mean asserting authority, but rather fostering trust, honesty, integrity and transparency in your leadership style (do what you say you will do). If your employees trust your judgement, they will not only follow your lead, but also work effectively when you are not around.
  • Establish relationships with each employee – Get to know your people as individuals. This means learning their skill-sets, what motivates them, their work habits and future goals. Regular, ongoing communication on a one-to-one basis will be an effective way of achieving this. This knowledge will prove extremely valuable to you, as it allows you to match each employee’s expertise and competencies to your organizational plan, and will help increase both productivity and job satisfaction. Additionally, including your employees in decision making as much as possible instead of just delegating tasks, giving them open-ended projects where they select the process and timelines and determine the best solution, will ensure you are developing your people along with the company.
  • Build relationships between your employees – As your team begins to work together in harmony and cooperation, examine the way they work together and communicate with each other to see how you might encourage a deepening of the inter-relationships of your team members. Stronger relationships between your employees also means deeper trust and respect. If there are conflicts, try to resolve them amicably by encouraging them to understand each other’s perspective and mediate where necessary. One way to do this is to brainstorm solutions, which also helps empower them and may lead to new creative solutions to a problem.
  • Foster teamwork – Once you have established relationships with and between your employees, you will be able to focus on helping them work together effectively. Encourage your team to share information both amongst themselves and within the larger organization. Having an effective communication system and not being afraid to ask your team members how they feel can go a long way to improving teamwork. Knowing and understanding what others are working on and how they are contributing to the vision and success of the organization helps improve working relationships.

Compare countries where the leaders take the time to meet and understand each other’s culture and challenges (like the G7) with those who try to operate isolated from the rest of the world, and you will understand how better solutions come from working together toward a common goal with regular, ongoing communication.

  • Evaluate performance – You will be able to assess your team’s performance not only on a fiscal basis, but also in terms of how effectively they display and preserve the values and culture of your company. This means that you will be able to evaluate the performance of your team as a whole alongside their individual performance. While great financial KPIs (Key Performance Indicators) and positive bottom-line results are one measurement of success, the turnover rate of your employees will also provide an indicator of whether you are operating with a high-performing team. We have all seen companies that have a revolving door of employees and are constantly in a training mode, so that their ability to focus on the longer term is challenged. On the other hand, a company with a well-developed and cohesive team and employee tenure above industry averages is very valuable in a succession plan.

No matter how smart, talented, driven or passionate you are about your business, your success as a leader depends on your ability to build, inspire and sustain a team – and get results. You are accountable to that, and the stakes are high. Just consider the recent firing of the Anaheim Ducks’ coach, or the recent troubles experienced by the British and Canadian Prime Ministers who have challenges within their teams.

Thought leadership: The successful leader is one who can recruit and grow a great functional team who are motivated by the leader’s vision and plans to execute on it. There is no doubt that functional teams outperform individual greatness by a very high margin. But just as true, is that dysfunction within the team needs to be quickly recognized and nipped in the bud. That’s even more important when you know that rough waters could lie ahead.

Changes Coming to Trust Filings

The CRA has been provided funding of $79 million over a five-year period, and $15 million on an ongoing basis, to support the development of an electronic platform for processing T3 returns. The goal: to address the government’s concerns about “significant gaps” in trust filing. By the year 2021, there will be new requirements for filing trust returns, and advisors in tax and financial services will need to come up to speed on this issue.

Specifically, certain trusts (including some trusts that are not currently required to file a T3 return) will be required to file and report the identity of all trustees, beneficiaries and settlors of the trust. In addition, it will be required that trusts report the identity of each person who has the ability to exert control over trustee decisions regarding the appointment of income or capital.

This initiative was first introduced by Finance Canada, in the February 27, 2018, federal budget. The commentary noted that a trust that does not earn income or make distributions in any given year is generally not required to file an annual (T3) return of income. Rather, a trust is required to file a T3 return if the trust has tax payable or it distributes all or part of its income or capital to its beneficiaries. In the 2018 budget, there is no requirement for the trust to report the identity of all its beneficiaries.

Now, the Finance Department wants to change all that and require annual reporting for specific trusts. As a result, from 2021 forward, reporting rules will change as follows for:

  • Express trusts that are resident in Canada
  • Non-resident trusts that are currently required to file a T3 return

An express trust, as defined in the budget documents, is generally a trust created with the settlor’s express intent, usually made in writing (as opposed to a resulting or constructive trust, or certain trusts deemed to arise under the provisions of a statute).

Some trusts are not affected. According to the most recent proposals, exceptions to the additional reporting requirements apply for the following types of trusts:

  • Mutual fund trusts, segregated funds and master trusts
  • Trusts governed by registered plans (i.e., deferred profit sharing plans, pooled registered pension plans, registered disability savings plans, registered education savings plans, registered pension plans, registered retirement income funds, registered retirement savings plans, registered supplementary unemployment benefit plans and tax-free savings accounts)
  • Lawyers’ general trust accounts
  • GRE (Graduated Rate Estates) and qualified disability trusts
  • Trusts that qualify as non-profit organizations or registered charities
  • Trusts that have been in existence for less than three months or that hold less than $50,000 in assets throughout the taxation year (provided, in the latter case, that their holdings are confined to deposits, government debt obligations and listed securities)

In summary, what needs to be reported: the identity of all trustees, beneficiaries and settlors of the trust, as well as the identity of each person who has the ability (through the trust terms or a related agreement) to exert control over trustee decisions regarding the appointment of income or capital of the trust (e.g., a protector).

Penalties effective for 2021 and subsequent taxation years. The following will be implemented for those who fail to file trust returns:

  • Late filing: $25 per day (minimum $100; maximum $2,500)
  • Additional late filing penalty: 5% of fair market value of trust assets (minimum $2,500) where the failure to file the trust return was made knowingly or due to gross negligence.