Sale of a Property: Business Income or Capital Gain?
You buy a house and sell it a few days, months or years later. Should you include the profit in your income? Would it be considered as business income or a capital gain?
As is almost always the case in taxation, the answers to these questions depend on several factors. The key is your intention at the time of the purchase and your subsequent actions that demonstrate that intent.
The distinction between business income and capital gains is important. In fact, 100 per cent of your net business income is taxable, whereas only 50 per cent of a capital gain must be included in your income. When it comes to real estate, this difference can amount to several thousand dollars in taxes.
What’s more, only a capital gain is exempt from payable taxes with a principal residence exemption.
In simple terms, the sale of a property is considered a capital gain if the property was purchased with the intent of holding on to it for a period of time and eventually selling it to profit from the increased value. In contrast, a property that was purchased with the intent of “flipping” it (i.e. quick resale) generates business income.
The length of time the property is held has an impact on the nature of any profits made on the resale, although this is not the only criteria. In general, a property held for a long time is an indication of a capital gain whereas short-term ownership indicates business income. There are no precise mathematical rules, such as “a year and a day”. As mentioned earlier, it is the intention at the time of purchase that is crucial. The period of ownership is just one indicator of this intention.
Some Concrete Examples
We will first analyze the simplest case: you buy a house in which to live, and you actually live there on a regular basis. After some time, since the market is favourable, you sell at a good profit.
In this case, you will realize a capital gain. You intended to live in the house long term and you clearly demonstrated this intent by actually doing so. The fact that you chose an opportune time to sell is irrelevant. In this case, you probably qualify for a principal residence exemption.
Second case study: the very popular “flip”. In this case, you buy a house with the purpose of renovating and reselling it. It will then be considered as a business income. Even if you hold on to the house for a while, your original intent was entrepreneurial in nature. You can deduct all relevant expenses incurred in selling the house, but you must include any profit in your business income.
Other cases are more complex. For example, you buy a house with the intention of residing in it, but you receive an unexpected offer, so you quickly resell it for a high profit. It is your original intention that counts. However, if you find yourself in this kind of situation too often, tax authorities could begin to doubt your real intentions.
On the other hand, a businessperson trying to do a quick flip on a property may be faced with a stagnant real estate market and may be forced to hold on to a home for several years, or even rent it out. These types of situations have many possible consequences and must be analyzed on a case-by-case basis.
Demonstrating a person’s intent is not always easy, since it is an intellectual process that only the person really knows. For this reason, concrete actions taken by the person serve as evidence in determining that intent. If you want to avoid problems, make sure to properly document your records and keep anything that might prove your original intent.