On October 3, 2016, the Minister of Finance announced a number of measures to address perceived abuses of the principal residence exemption. The CRA had historically waived the requirement to report the sale of a home where the entire gain was sheltered by the principal residence exemption. However, individuals selling their home starting on January 1, 2016 will be required to report the sale in their personal income tax return.

In addition to the “new” reporting requirement, it is important to remember that a forfeited deposit resulting from a failed transaction should also be reported. In most real estate transactions, residential or commercial, a buyer is required to pay a deposit in respect to the property being purchased. The terms of the agreement usually provide that in the event the offer is accepted and all conditions are satisfied or waived, and the buyer fails to perform under the contract, the deposit will be forfeited to the seller.

Take a situation, for example, where a Buyer offers to purchase the Seller’s principal residence for $300,000 and pays a $15,000 deposit. After all conditions are satisfied or waived, the parties have a firm deal. However, what happens when a Buyer refuses to close and the $15,000 deposit is forfeited and paid to the Seller? How should the deposit be treated by the Seller for tax purposes?

CRA takes the position that, in this scenario, the Seller is considered to have disposed of a right under a contract and the $15,000 are the proceeds of disposition. Assuming this right is capital property as defined in section 54 of the Income Tax Act, the Seller will realize a capital gain. This position appears to be correct, as the definition of “disposition” in subsection 248(1) includes any transaction or event by which the property is an agreement of sale and the property is in whole or in part cancelled.

Can the Seller claim a principal residence exemption to shelter the capital gain? Unfortunately not. Since the right arising out of the promise is a separate property from the principal residence, the right does not qualify and the Seller cannot claim an exemption.

If the Seller realizes a capital gain, does the Buyer realize a corresponding capital loss? Unfortunately, the answer is also no. CRA takes the position that there is no disposition of property by the Buyer and as a result there would be no capital loss within the meaning of paragraph 39(1)(b) of the Income Tax Act.

Given that the CRA is focused on the real estate industry, it will be interesting to see whether we will start seeing reassessments for unreported income, which may include interest and penalties, resulting from the payment of a forfeited deposit after a real estate deal falls through.

This post is intended to provide general information concerning developments in the law and is not intended to provide legal advice in respect of any particular situation.