The hot housing market we’ve experienced in the City of Toronto (and Vancouver) over the last several years has presented an opportunity for home buyers to accumulate wealth through the prudent and lawful purchase and reporting of real estate. As part of your taxable income, you typically need to pay money on the return on your investments when they increase in value, including real estate.
In the case of property investment, when you sell a property, you realize capital gains (profits after expense). There are exemptions for paying capital gains tax, which are advantageous to the investor because it improves the overall return on the investment; if the home that you sell is your principal residence, you are exempt from paying that capital gains tax.
However, the reporting framework around the system – as it had been constructed until recently – not only offered an opportunity for legitimate real estate investors, but it’s fairly sizeable loopholes allowed for shady investors to circumvent the system and perpetrate fraud.
Sliding through these loopholes has created a set of problems for the property market in urban centres. Tax revenue is depleted (which could help fund other programs that are much needed to compensate for the high cost of living) and fraudulent activity contributes to eroding affordability and puts pressure on already tight vacancy rates. Speculative investment draws on the already limited supply for the homebuyer pool, reducing opportunity and pushing up prices for legitimate homebuyers. The result? Economic, socio-economic, and demographic fallout.
Government intervention that aims to keep the Canadian real estate market under control is nothing new; we’ve seen the Federal Government intervene at several intervals over the past few years with changes to mortgage lending practices, most recently with the new mortgage stress test which took effect at the start of this year. We’ve also seen the introduction of the Fair Housing Plan from the Provincial Government that has addressed a number of the factors that have contributed to an overheated Toronto real estate market. We’ve seen activity retreat and prices begin to moderate in the months after the Fair Housing Plan went into action, though – as an aside – if you’re reading my Tales From The Real Estate Trenches, I’m documenting a resurgence in competition in the original City of Toronto.
Now, there are new initiatives being taken on the Federal level to try to not only aid in the balance of the market, but to crack down on investment fraudsters whose greed is creating barriers for legitimate investors and home owners.
Recognizing the growing potential for fraud with the loopholes in the reporting framework, made more of a draw in a hot real estate market, was undoubtedly the impetus for the Government to step in last June and update the Principal Residence Exemption tax. This marks one of the first moves towards streamlining reporting practices. We discuss these amendments in detail in our blog, Changes To Canada’s Principal Residence Tax Exemption.
While some don’t like paying taxes or abiding by regulations which can seem restrictive; those ruled by greed disadvantage those of us whom are fair. And we all need to remember that housing isn’t just an investment opportunity; it provides shelter, so when that is impacted, an entire subset of problems are created that go far beyond the investment or revenue producing opportunity.
Canada Revenue Agency Targets Shadow Flippers
The CRA’s increased awareness and aggressive stance in real estate reporting and tax avoidance is in part due to the affordability crisis in areas like Toronto and Vancouver.
Recently, the CRA has ramped up its efforts to identify speculative investors in the City of Toronto, specifically on the practice of shadow flipping in the Condominium market. Shadow flipping is when a condo is bought from a developer and then sold to another buyer in quick succession before it is completed. Typically, profits from flipping real estate are generally considered to be fully taxable as business income, but the existence of several loopholes, along with a lack of technology and tracking, this fraudulent practice has proliferated.
The CRA is currently investigating almost 3,000 pre-construction purchases in Toronto, widening the lens on these investors. It appears that their suspicions are correct. In audits of completed during the last fiscal year (ending March 31 2016), the CRA recovered $18 million in income tax and $32 million of GST/HST in Ontario alone. Additionally, across the country, they issued $10 million of penalties, with the highest weighing in at almost $2.5 million. It certainly makes the case for compliance, especially from an investment standpoint. Although for investors looking to make a quick buck through shadow flipping, this certainly takes a bite out of their return on investment.
There is multi-benefit here to legitimate homeowners in Toronto through this crackdown. Enforcing compliance will deter shady investment because the returns are less attractive. This will help add stock to the market, which will help with affordability. Furthermore, it takes action against fraud. It’s not to say that this extra revenue would necessarily help fund other programs that would directly benefit Toronto homeowners, but it legitimizes property investment and helps to keep checks and balances in place for a system that we’ve democratically elected.
Here are some stories on CRA’s recent crackdown on shadow flipping: “CRA Analyzing Pre-Construction Condo Flipping Cases In Toronto For Tax Avoidance”, “How The CRA Is Cracking Down On Non-Compliance In Canada’s Hottest Housing Markets “and “CRA Probes Presale Condo Flips In Toronto As Part Of Real Estate Crackdown.”
‘Ghost Immigrant’ Fraud
These CRA loopholes are also creating a conduit for wealthy foreigners (termed “Ghost Immigrants”) to vastly underreport their income. Their scheme is to purchase multiple properties, fulfill the minimum guise of residing there, and then return to their home countries. In this way, the loophole allows them to avoid the capital gains tax that SHOULD be paid on non-primary residences. The problem here is two-fold. It’s unfair and illegal for some people, because they can leverage the system to not pay the appropriate taxes. It’s easy within our system to fraudulently meet the requirements of physical presence and maintaining permanent residence, which would pave the way for citizenship and the other benefits awarded to Canadian citizens. In a country that embraces immigrants and celebrates all cultural contributions as an essential fabric of our national identity, the idea of contriving the system to reap these rewards because of the proliferation of fraud is troubling.
Secondly, because this loophole provides a secondary “benefit” (i.e. tax evasion), it places additional strain on an already tight housing supply, impacting affordability.
Recently, a Vancouver court case of wealthy Chinese families Fu versus Zhu came to light that exposed exactly how deep this particular line of fraud runs. Chinese multi-millionaire Guoqing Fu had the means to purchase a number of lavish homes in Canada, yet only reported $97 in annual international income on his Canadian tax return, which was exposed when these two families turned on each other.
This case shines a rather abrasive light on the serious flaws that exist currently in the CRA’s reporting system. This case showed how adept not only how adept the Fu and Zhu families were in circumventing the tax system when they bought and sold homes, but that these signs of weakness in the system are well-known amongst the community of would-be fraudsters, which suggests that stricter audits and reporting processes are a real necessity, sooner rather than later.
Click here to read some stories on this court case: “How To Fix Canada’s ‘Ghost Immigrant’ Fraud Problem“, “Wealthy ‘Ghost Immigrants’ Using Empty Homes To Claim Citizenship: Tax Expert” and “Explosive B.C. Court Case Details Seven Migration Scams“.
Here is another story that demonstrates how foreign buyers were able to sidestep another policy-driven program, avoid taxes and put pressure on housing markets in Toronto and Vancouver: “How Over 46,000 Wealthy Immigrants Took A Back Door Into Vancouver And Toronto’s Housing Markets“. Under a foreign investment incentive program through Quebec (Quebec Immigrant Investor Program). Under the program, international business people with net assets of 1 .6 million, who made interest-free investment of $800,000 in Quebec. In return, the government returns their money after five years, with the stipulation that these investors were to remain in Quebec. However, there is data that shows that the vast majority of them have moved out of Quebec the Toronto and Vancouver areas. The point here is that it can be problematic to offer tax incentives without following through the enforce the requirements to acheive the goals of the tax exemption.
What all of this underscores is exactly how vital a role housing plays, not only in the financial health of our city, but its socio-economic health as well. It is the risk of this far-reaching influence that has caused governing bodies to step up and intervene on multiple fronts.
Did you enjoy this blog? Here’s some of my recent posts which offer more insight on Toronto real estate:
How Our Three Levels of Government Are Impacting Toronto Real Estate Right Now
7 Reasons Why Toronto Real Estate Prices Have Skyrocketed Over The Past Decade
How Demographics Affect Toronto Real Estate
And here’s my recent Forecasts on Toronto real estate:
Urbaneer’s Winter 2017/2018 Toronto Real Estate Forecast – Part One
Urbaneer’s Winter 2017/2018 Toronto Real Estate Forecast – Part Two
Are you considering buying or selling your property? In order to navigate Toronto’s complex real estate market, you need to not only accurately chart a path, you need to have a comprehensive view of market influences. With decades of in-the-trenches experience and a multi-disciplinary education in housing, my team and I can offer relevant support to understand the dynamics of our housing industry.
We are here to help!
~ Steven
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage – (416) 322-8000
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