Tax Implications on Assignment of a Purchase Contract

Tax pitfalls to avoid when buying or selling a new-build contract

Thinking of selling that under-construction home or condo for a profit? Don’t forget to add tax to your calculations.

A boom in new-build sales has seen an increase in original buyers selling their contract with the builder to tap into a heated housing market. Called “assignment of purchase” agreements, such deals have tax implications for both the person who sells the contract and the person who buys it. 

Any profit realized from such assignment sales must be reported by the assignor and could have varying implications. These implications include the profit being treated as fully taxable business income or capital gains income. There are also indirect tax implications, i.e. the GST / HST. As a result of the challenges associated with them – including increased scrutiny from the Canada Revenue Agency (more on that below) – some builders are including “no assignment” clauses in their purchase agreements.

Definitions

To avoid confusion, let’s start by defining some concepts. When you buy a new home build or condo under construction, you sign a purchase agreement contract. If – with permission from the builder – you sell that purchase agreement to someone else before taking possession, that is called an assignment of purchase. You become the assignor and the buyer the assignee.

However, what might seem like a simple transaction becomes more complex when addressing the tax issues associated with the deal. Any profit made on the sale of the original contract is taxable; that’s a given. But how much tax and who pays what is debatable.

Capital gains income or business income?

The profit made from an assignment of purchase agreement will either be designated as business income, which is fully taxable, or as a capital gain, which is currently taxed at 50 percent. The tax treatment depends on the initial buyer’s intention on signing the contract on the new build.

If you’ve bought or sold a home or two, you might think the profit will automatically fall under income from capital gains and be taxed accordingly. For example, maybe you originally signed the agreement and paid the deposit with the intent of renting out the property once it is built. However, you changed your mind and sold the contract as an assignment of purchase when the market got hot. In that case, it is likely the CRA would consider the profit from the sale to be categorized as business income, even though your original intention was to hold it as a rental property. The CRA would argue these types of transactions are usually undertaken with the intention of making a profit and the time between when the contract was initially entered into and when it was sold was a very short period.

However, if you bought the property with the intention of using it as your principal residence but sold it before possession, you would not have lived in it yet. In that case, it doesn’t qualify for the principal residence exemption and the profit will be taxable. But you could argue it should be taxed as a capital gain rather than business income as your original intention was to occupy it as your personal home.

As in the previous example, the CRA would also be inclined to consider the profit from this assignment of purchase as business income due to the short period of time from acquisition to sale and would assume that it is a “flip” and that the buyer’s intention was to make a quick profit from the sale of the contract.

GST / HST

Another big question is what happens around GST/HST - and the new housing rebate.

If the assignor proves their intent when buying the property was to use it as a principal residence, they won’t have to collect and remit GST/HST on the consideration received. The assignment will be GST/HST-exempt. But if the CRA determines the assignor’s intent was to flip the property, then the assignor could be required to collect and remit tax on the transaction, either on the assignment fee or on total price paid by the assignee for the home, depending on the terms of the assignment agreement.

For the assignee, you probably know you assume liability for the home with the assignment of the purchase agreement. What you likely don’t know is you might not be able to claim the GST/HST new housing rebate (which is typically given by the developer as a credit against the purchase price). If the assignor is selling the home GST/HST-exempt, the assignor will probably receive the benefit of the rebate under its purchase agreement (as long as they intended to use it as a residence).

However, if the assignment is taxable, the assignee should qualify for the rebate, although the amount of the rebate will be affected by the price paid for the assignment. Therefore, it will be incumbent upon the assignee to determine whether the new housing rebate opportunity still exists and the amount of any available rebate.

In the CRA spotlight

At the same time, be aware the chances of being audited are high if you participate in an assignment of purchase. The CRA continues to scrutinize real estate and construction transactions with beefed-up auditing teams. The 2019 federal budget proposed to create a Real Estate Task Force. This task force essentially combines auditors and business-intelligence officers with specific knowledge, training, and expertise to scrutinize real estate transactions in which parties have failed to pay the required taxes.

That year, assessments on real estate-related taxes jumped by 65 percent, and penalties levied by the CRA more than doubled, to $57 million.

Conclusion

If you have or are planning to participate in an assignment of purchase transaction, be prepared to pay taxes on the deal and to be audited. When you get a letter from the CRA questioning the transaction, reach out to a chartered professional accountant immediately to help position your case.

If you expected your sale to be taxed as business income on the transaction, it’s not a big deal. But if you did not expect to be charged any tax on the transaction or expected the tax rate to be reflected as a capital gain, it would benefit you to connect with an experienced professional.

For more information contact Bruno Lucente, CPA, CA, at [email protected]