Some questions are really tough to answer. For instance, my brother-in-law, Ned, who is a university professor and a real thinker, recently e-mailed me the following questions to ponder: What do you do when you see an endangered animal eating an endangered plant? If a turtle doesn't have a shell, is he homeless or naked? Why do they put Braille on the drive-through bank machines? Is there another word for synonym? If one synchronized swimmer drowns, do the rest drown too? And if the police arrest a mime, do they tell him he has the right to remain silent?
Good questions. Some tax questions are equally tough to answer. Such as: If you buy a home, fix it up and sell it for a profit, how will that profit be taxed? As a capital gain, or business income?
Adventure in trade
Assuming you're not in the business of buying and selling properties for a profit (in which case it's clearer that the profit will be taxed as business income), you may still face tax on your profit as business income, and not a capital gain.
You see, there's the concept of an "adventure in the nature of trade (AINT)." If your purchase of the property is considered an AINT, you "ain't" going to enjoy capital gains treatment. This also means you won't be able to claim the principal residence exemption. Rather, the profit will be taxed as business income.
The Canada Revenue Agency (CRA) will look at several factors, derived from past court decisions, to determine whether or not the transaction was an AINT. The first three factors deal with your "intention" when you bought the property, and the balance deal with your "business practices." Here they are.
Your intention when you acquired the property, and the feasibility of that intention makes a difference. If you intended to flip it for a profit, this will be an AINT. By the way, the CRA will also look at your secondary intention. If you always had it in the back of your mind that, as a backup plan, you might sell the property for a profit, this may be enough to consider the deal an AINT.
The extent to which your intention was carried out, that is, your actual course of conduct, is also important. So is evidence that your intention changed after acquiring the property. If you intended to keep it, but had to change your mind later for a valid reason, that could work in your favour.
The nature of your business, profession or trade and how close it is to real estate transactions will be looked at. The closer your regular work is to real estate transactions, the more likely your transaction will be an AINT.
How you finance the purchase is critical. The greater the amount borrowed and the shorter the term of the financing, the more this looks like an AINT. And the shorter the time you own the property, the more likely it will be called an AINT.
The CRA will look at the frequency of similar transactions you have done. If you have a history of buying and selling properties, there's a greater likelihood of this being considered an AINT.
If you put the property up for sale or took other actions to attract buyers, particularly shortly after you bought it, that could indicate an AINT.
The existence of co-owners, especially others who do not intend to live in the place, may indicate that this is an AINT.
The best advice? Visit a tax pro before a purchase, to build your case for capital gains treatment.
Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.