Q. Three friends and I pooled our money ($100,000 total) two years ago as a down payment to buy a rental condo in Toronto. All four of our names are on title. We flipped the condo this past May for a total profit of $120,000 after expenses. That’s a $30,000 capital gain for each of us, which is pretty good.
This is where it gets tricky: I plan to declare the capital gains from the condo sale on my taxes for 2019, but a couple of my friends say they aren’t going to—mainly because they don’t think it’s a huge amount of money and they believe they likely won’t get caught. I also declared my share of the net rental profit for 2017 and 2018—but at that time, two of my friends did not. What happens if the Canada Revenue Agency (CRA) audits one of us? Will I have to pay their share of the capital gains taxes and penalties on the sale of that condo? What can I do now to make sure that doesn’t happen? –Marcus
A. Hey Marcus, you did well on your rental property! However, your partners may not fare as well.
When you have a rental property you’re required to:
- Claim the rental income on your income tax return.
- Complete this form when you sell the property.
- Claim the capital gain on your income tax return.
If you fail to report the income or capital gain, you may face interest charges on the amount of tax owing, plus penalties that may be larger than the interest owing on the tax. In addition, if you knowingly falsify or omit information on your return for more than one tax year, which your friends have done, the penalties increase.
I’m assuming you each put in $25,000 and have 25% ownership in the property. You’ve been claiming 25% of the rental income over the length of time you owned the property on your return, so you should be okay. The partners that didn’t claim the income may face penalties and interest charges on the tax owing if they are caught.
There may have been a time before the commonplace use of computers when your friends could have gotten away with their plan of omission, but today CRA has easy access to information. When the property was sold, the sale was registered at the provincial registry office, which CRA has access to. It is not worth the risk of getting caught.
Your friends may be thinking they’re in the clear because you claimed the rental income two years in a row, and they weren’t reassessed. CRA normally has three years to reassess a tax return after the initial assessment; however, if they believe someone knowingly falsified or omitted information they can go back further.
Everyone is allowed to manage their affairs in such a way to minimize the amount of tax they owe. What we’re not allowed to do is knowingly falsify or omit information, or evade taxes. If we do, we’re subject to interest charges and penalties.
You can read about the interest and penalties in full here; I’ve laid out some highlights below as well:
The current interest rate of 6% is charged on any unpaid amounts per tax year. If your partners didn’t claim the rental income in 2017 and are later assessed, they’ll be charged interest on the amount of tax owing in 2017, starting May 1, 2018. Plus, they still have to pay the taxes owed, and likely penalties also.
Repeated failure to report income penalty
The partners who didn’t report the income will be faced with the lesser penalty of 10% of the amount of income they didn’t report, or 50% of the difference between the tax they paid and should have paid.
False statements or omissions penalty
Your partners also knowingly omitted including the rental income on their returns, so this is another possible penalty they are subject to, which is equal to either $100 or 50% of the tax difference, whichever is greater.
Fortunately, CRA does offer a possible way out through their Voluntary Disclosures Program (VDP). Your partners will still have to pay the tax and interest charges, but they may be able to avoid the penalties.
Marcus, given that you have properly reported income and paid taxes owing, you should be okay, but it is best to discuss this with your accountant.
Not disclosing income on your tax return really isn’t worth the risk. The interest and penalties are high, and in this case, the CRA has access to the unreported information. Your situation is a good example of why a partnership agreement is a good idea when purchasing an investment property with others.
Allan Norman is a Certified Financial Planner with Atlantis Financial Inc. and can be reached at firstname.lastname@example.org
This commentary is provided as a general source of information and is intended for Canadian residents only. Allan offers financial planning and insurance services through Atlantis Financial Inc.
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