Q: I have a question about capital gains vs business income. For my real estate investments, Revenue Canada (CRA) is not allowing me to claim capital gains because they say it’s a business income. Is this correct?
Answer: Capital gains vs. business income
This is a classic argument with the CRA and certainly one of the most litigated areas in tax: capital gains vs. business income. The answer is far from clear in many cases. The CRA will be looking to a variety of factors in judging what an investor’s primary and potentially even their secondary intention is with a property. Generally speaking, where an investor is looking to earn reasonable profits through renting a property, they are more likely to be considered earning a capital gain on ultimate disposition. Alternatively, where the primary motive of owning the property is to subsequently sell it for a profit, this is more likely to be considered on account of income. Proving your intention can be a little more complex of course.
Wrong documentation can be costly
A big mistake that we frequently see is investors have documentation and agreements outlining the fact that they intend to sell the property at a specified point in time. This pretty much creates a “slam dunk” for the CRA in the capital gains vs business income argument. For example, if you enter a joint-venture with another individual and agree that in five years you will sell the property and split the proceeds, you’ve basically admitted that your intention is to sell the property in five years. Thus, welcome to the world of “income”.
Timing?
A large fallacy that we encounter is the belief that if someone holds a property for a certain period of time (often two, three or five years is suggested), they will be considered to have earned a capital gain regardless of the particular situation. There are plenty of examples of court cases where holding periods are shorter than this and still generate a capital gain, and alternatively much longer while generating income.
Preparation helps with capital gains vs business income argument
A small amount of preparation and planning while buying the property can greatly enhance your chances of influencing how the property will be taxed. Knowing the various factors the courts look to in deciding these issues goes a long way and are relatively well laid out in a CRA Interpretation Bulletin.
More questions?
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Remember – circumstances are unique! This information is summary in nature. Seek out advice from your tax advisor about your specific situation.
