Too Many Investors are Committing Unintentional Tax Fraud
“It’s not what you make that matters, it is what you keep.” This old business adage is very true, but at the same time is often misused in order to justify an action squarely in the ‘grey area’ of business. In the real estate game there are many opportunities to cross the line into the grey area – strategic investors know these short-cuts almost always lead to unintended (and often expensive) consequences down the road.
Wandering into this grey area may not bite you immediately, but is much like a great predator that sits there waiting to strike when you least expect it. It could be a document you signed that was incorrect, it could be a declaration you made to a bank, partner or purchase, incorrectly claiming something on your taxes.
Making an incorrect or inaccurate claim when you file your taxes
No matter what misinformation you have declared, you have dramatically and purposely increased the risk to your portfolio, to your financial health and the risk to your health that long-term stress. In fact, you have set up your own personal “Sword of Damocles” (a term used to describe a sense of foreboding engendered by a precarious situation, especially one in which the onset of tragedy is restrained only by a delicate trigger or chance). Why do people take this chance? Because often times they have received inaccurate advice, or they believe the risk is minimal. Or, sadly, they believe they are smarter than the ‘average guy’ and can fool anyone.
Let me state right here, just as we have for years, the risks to playing in the grey area are NOT minimal (especially when you are misleading the CRA): the risks of being caught especially now are dramatically increased, it is not if you will get caught trying to cheat on your taxes in real estate: it is when you will be.
You, as the justifying server in this metaphor will eventually lose this argument – time after time after time. I have heard ALL of the justifications for claiming a short term property flip into a capital gain – but no matter the approach I always go back to ‘What Was Your REAL Intention?’
Serving Up an Order of Intent
This disconnect between CRA and speculators has been in the REIN spotlight for decades, in fact we regularly have accountants and financial experts speak to Members about the dangers of playing in the grey area of the business, especially on the tax side. Our clear recommendation is to not do it, ever. No matter how many “others are doing it.”
Like they have done before with those terrible tax savings/donation schemes that seem to be everywhere, the CRA has now clearly declared that they will be looking to assess or re-assess short term property transactions (including contract assignments) as income and thus unavailable for any capital gains deductions.
In other words, they want what they ‘ordered’ and aren’t going to be taking any justifications for you trying to serve them something else completely.
Intent is the key
Before you file taxes on your last or next short-term flip ask yourself: “What was my true intention for this property and can I prove it in a court of law?” It really is as simple as that.
Moving in and making it your personal residence by putting your toothbrush in for a few nights or sleeping there a couple of nights does NOT change your intention for the property. If you intended to buy it, rent it out long term and create actual investment income from it, then you have a chance. However, if your intent was always to make a quicker-turn dollar and your paperwork shows that (for instance: a short term mortgage; or marketing of the property before or right after possession; or even proof that the rental income could NEVER cover all your expenses and provide you an income) then you are clearly in an income transaction and would be advised to claim it that way.
It’s not just the tax you will be charged, you will also be charged interest and penalties which are often larger than the past tax due.
Strategic investors clearly understand that the risks FAR outweigh the rewards.
Oh No, Now What?
It is time to be proactive.
Step one, this week, analyze your past tax filings. Review them to ensure that any of your shorter term deals (there is no stated time, by the way, it is all to do with your intention), have been properly declared on your tax filings. If you suspect not, ask your accountant about it and get a very clear written answer to: ’What is my risk in this?’ Discuss whether it is worth re-filing or not.
Step two: make sure you are not mixing short-term quicker-turn properties in the same company (or personal name) with long-term buy and holds. If they are mixed, capital gains even on the longer term properties may be denied.
Step Three: After the busy tax season is over for your accountant, have a clear heart-to-heart discussion with them about how you wish to deal with this matter moving forward. Listen to their advice, measure your risks versus rewards and set a clear mandate for clarity and full-disclosure moving forward. Make sure you are satisfied with the answers; remember, it is you who takes the ultimate risk if you file incorrectly.
Step Four: Finally in all cases, make sure you are getting PROFESSIONAL advice from accountants and lawyers who have INVESTMENT real estate experience.
I am not an accountant and nor is this article professional accounting advice. However, it is my advice that you do whatever you can to remain far away from the grey areas that seem so tempting but in reality just add an enormous amount of unnecessary risk as you build your portfolio to your ultimate freedom.
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