Lots of people like to dabble in real estate when markets are hot. But there could be an unintended tax issue which could significantly erode wealth.
The issue is this: do you hold the property for personal use, or are you in fact in the business of buying and selling real estate?
When real estate is held for investment purposes, any income it earns will be “income from property,” generally in the form of rent. Upon disposition of the property, any increase in value will usually be taxed as a capital gain. However, if you are continuously flipping your properties, it’s possible you’re in business.
The Income Tax Act does not prescribe specifically when gains from the sales of real estate will be considered income rather than capital. However, the courts have considered factors such as the following:
- geographical location and zoned use of the real estate acquired;
- the taxpayer’s intention with respect to the real estate at the time of its purchase; and the extent to which the intention was carried out;
- 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 throughout which the real estate was held by the taxpayer,
- the existence of persons other than the taxpayer who share interests in the real estate;
- the nature of the occupation of the other persons who share interest as well as their stated intentions and courses of conduct;
- factors which motivated the sale of the real estate; and
- evidence that the taxpayer and/or associates had dealt extensively in real estate.
The more closely a taxpayer’s business or occupation is related to real estate transactions, the more likely it is that any gain realized by the taxpayer from such a transaction will be considered to be business income (100% income inclusion on a business statement) rather than a capital gain (report on Schedule 3 as a capital gain—50% income inclusion).
It’s Your Money. Your Life. Consider how closely your intentions and subsequent financial actions affect your after-tax return on investment. You may be missing important considerations a tax auditor will zero in on, to your surprise and financial detriment.
Evelyn Jacks is president of Knowledge Bureau and author of 51 books on tax and personal wealth management. She is also the founder and director of the Distinguished Advisor Conference (DAC). The theme of the 2014 three day think tank in Horseshoe Bay, Texas Nov 9-12 will be “Think BIG: Find the Sweet Spots in Wealth Management” Follow Evelyn on Twitter at @EvelynJacks.