Buying a house, doing some work to it and selling it for $100,000 profit a few months later sounds like a lucrative proposition, but is it really?
Canada Revenue Agency will tax the profit as income not capital gains. In this instance, the full $100,000 profit would be taxed at your marginal tax rate.
Here is an example of why I prefer to flip the house.....later: Buy, Add Value, Refinance (BAR) then hold
Buy & Add Value
- Property purchase price $500,000
- Downpayment, closing costs & 4 month carrying costs: $113,000
- Renovations: $100,000
- Refinance property at $600,000
- New Mortgage (80% of value): $480,000
- Total Capital (including closing costs): $144,609
- Hold property for 5 years
- Annual appreciation: 3%
- Annual ROI w/ cash flow: 18.55%
- Property equity after 5 years: $237,438
If property is sold after 5 years, only 50% will be taxed at your marginal tax rate. Assuming a sale price of $675,000, only $87,500 out of the $175,000 ($675,000-$500,000 divided by 2) would be taxed at your marginal tax rate. Disclaimer: Always consult a professional accountant who specializes in real estate investment to guide you through CRA's rules and regulations. Capital Costs Allowance are not taken into consideration in this example.
To summarize the 2 options:
1. Sell Now: $100,000 profit taxed at marginal rate
2. Sell in 5 Years: $237,438 profit (difference between property value and remaining mortgage balance) plus $41,588 in cash flow over 5 years, only $87,500 taxed at marginal tax rate
Advanced real estate investor tip: Don't sell the property after 5 years, refinance it to pull equity to buy another investment property which would defer paying capital gains taxes to a future date and build portfolio by acquiring another investment property.