Tax for Estate Planners: Accidental Flip

For trust practitioners drafting joint partner and alter ego trusts, beware the new house-flipping rules.

For BC practitioners, there are two new rules: federally, subsections 12(12)-(14) of the Income Tax Act (“ITA”) and provincially, the Residential Property (Short-Term Holding) Profit Tax Act (“PTA”).

These rules either convert capital gains (or exempt gains via the principal residence exemption) on certain sales of homes into income (ITA), or impose a brand new 20% tax on profits (PTA).

In this note I’ll highlight traps for the unwary with these two laws, and close with possible workarounds.

ITA

This rule applies to sales of housing units held for 365 days or less. As noted, if it applies, capital gains (or gains exempt under the principal residence exemption) become income, and thus fully taxable. Any losses are denied.

A trap for our purposes is the starting date for the holding period.

If a trust sells a home (a home which the settlor may have lived in and owned for decades), and the sale is within a year of the transfer to the trust, this rule would apply to deem the otherwise exempt capital gain to be income.

There are exemptions to the rule (the death of a taxpayer, for example, or divorce, disability, etc.). None of these apply here.

PTA

Generally this rule applies to sales within 2 years of acquisition (the tax rate declines after a year). A summary of this statute is outside the scope of this note, but generally it’s a 20% tax on “profits”.

Profits are calculated based on actual proceeds received less the cost to purchase the property and other additions not relevant here. In circumstances where a taxpayer acquired the property for nothing (for example, on transfer to a trust), the cost is $0, and the entire proceeds would be taxable.

There is an ownership continuity rule. If the recipient of the property is related to transferor, then the recipient is considered to have owned the property since the transferor acquired it.

However, for alter ego and joint partner trusts, where the trustees are typically (not always) the settlors, this continuity rule won’t apply because individuals are not considered related to themselves.

Thus, on a sale of a home within the first two years after transfer to a trust, you can expect the tax to apply on the entire proceeds received.

Workarounds

It’s still early days on these pieces of legislation, but I have a couple comments on possible workarounds. Make sure you do your research before implementation:

• For the ITA, you could realize the full capital gain on transfer into trust. This is done by electing out of the rollover under subsection 73(1) and claiming the principal residence exemption. If a sale is made in the first year of the trust, the rule will still apply, but the applicable tax may be much lower.

• For the PTA, either tell your client not to sell within the first two years, or perhaps have the settlor’s child be the trustee (a common enough practice) in order to activate the continuity rule.

Flipping?

In both cases, the issues here seem to me unintended quirks of the legislation. These sales aren’t “flipping” in the traditional sense.

And issues go beyond those discussed here. For example, the ITA rule applies for a sale after a distribution to a beneficiary of an estate or trust, a rollover to a corporation or an amalgamation of two or more corporations. Each restart the 365-day ownership period. So too for these under the PTA if the recipient of the property is unrelated to the transferor or an exemption does not apply.

If you have any further questions about these rules (or tax questions related to estate planning generally), you can feel free to reach out to us. The author can be contacted directly at jonathan@rkwlaw.ca or 604.425.1123.