House “Giveaway” Could Turn Principal Residence Gain Into Taxable Business Income

29 janvier 2019 | Carolyn S. Inglis

( Disponible en anglais seulement )

In a recent news story out of Millarville, Alberta, a woman who has been unable to sell her home has instead decided to give it away in a letter writing contest. The woman is required to downsize because she can no longer navigate the stairs in the large property. Unable to find a buyer, she decided to try a contest after seeing something similar in a movie. The woman is charging a $25 entry fee, and entrants must write a letter explaining how the house would change their lives. The woman is hoping for 60,000 entries, and the total number of entries must reach a minimum number for the contest to go ahead.

At first blush, this contest may appear to be an ingenious way to get her money out of a home that is not selling. When one looks at the tax consequences of this contest, however, she may have turned a tax-free disposition of her principal residence into taxable business income. The question is whether the entry fees can be considered proceeds of disposition of the property.

The homeowner is disposing of the property as part of the contest. Her method of disposition is presumably by way of a sale or by way of a gift. If the disposition is a gift, then by definition she receives no consideration for the disposition and the entry fees from the contest would not be proceeds of disposition of the property. The woman will be deemed by subparagraph 69(1)(b)(ii) of the Income Tax Act (Canada) (the “Act”) to have received proceeds of disposition for the property equal to the fair market value of the property. Any gain on the deemed disposition could presumably be sheltered by the principal residence exemption in paragraph 40(2)(b) of the Act. The entry fees, however, cannot be sheltered by the principal residence exemption if they are not proceeds of disposition.

If the disposition is a sale, then the question is whether the proceeds of disposition for the property consist of all of the entry fees, or only the winning entrant. “Proceeds of disposition” is defined in section 54 of the Act to include “the sale price of property that has been sold.” The homeowner is not selling or disposing of the property to the unsuccessful entrants; therefore, it is unlikely that the amounts received from the entrants can be said to be the property’s “sale price”. The amounts raised would be coming from many different individuals who, except for the winner, would receive nothing in exchange for their entry fee. The unsuccessful entrants have paid to enter a contest. They have not paid for property, and there is no binding agreement for the sale of the property. If we consider all of the entry fees to be the sale price of the property, this creates a disconnect between the proceeds of disposition of the homeowner and the cost to the winner; the winner, who has only outlaid $25 of his or her own funds, cannot reasonably be said to have a cost equal to the total entry fees generated from the contest. If the owner is, in fact, selling the home to the winner, then the sale is presumably between the woman and the winner, who has only paid $25. The homeowner’s proceeds of disposition in such circumstances may only be the $25 entry fee paid by the winning entrant.

The fact that the entry fees may not be proceeds of disposition of the property does not mean that the fees would not otherwise be taxable. The amounts raised are unlikely to be considered a windfall. Factors indicating a windfall include the taxpayer made no organized effort to receive the payment and the taxpayer neither sought nor solicited the payment (CRA Folio S3-F9-C1). The contest is an organized effort to solicit funds and, as such, is unlikely to be considered a windfall under the Act.

If the entry fees are not proceeds of disposition, they are in all likelihood business income that is taxable under subsection 9(1) of the Act. This is consistent with the position of the Canada Revenue Agency (the “CRA”) on crowdfunding (CRA Folio S3-F9-C1) and on fundraising in general (CRA document no. 2014-0518841E5, May 30, 2014) (See also Gill, “CRA: Crowdfunding Receipts are Taxable”, Canadian Tax Focus, November 2013). If the entry fees are business income, they would be included in income under subsection 9(1) of the Act and would be taxable at the woman’s marginal tax rate. In Alberta, the combined top marginal tax rate for individuals in 2018 was 48%. Assuming the woman managed to achieve her goal of 60,000 entries, which would raise $1.5 million, she would be liable for income tax of up to $720,000 on this amount (not including expenses).

Moreover if the entry fees are, in fact, business income and not proceeds of disposition for the property, the principal residence exemption would not apply. In addition, the homeowner’s loss from the disposition of the home would be deemed nil by subparagraph 40(2)(g)(iii) of the Act because the home is personal use property.

What about the winner of the contest?

The news articles regarding the contest indicate that it is not a lottery, due to the requirements of the Alberta Gaming, Liquor and Cannabis Act. As such, the house cannot be considered a prize from a lottery. If the house is considered a gift, the winner will not be required to include the prize in income at the time of receipt and will be deemed by paragraph 69(1)(c) of the Act to have acquired the home at its fair market value at the time of acquisition. The winner would, in those circumstances, only be taxed on the increase in value of the property when it is eventually sold. The winner has paid an entry fee, however, which brings the home’s status as a gift into question. It is the CRA’s position that where a contestant has purchased a ticket, the cost of the ticket will be the winner’s cost of the prize for the purpose of calculating a capital gain or loss (CRA Folio S3-F9-C1). The winner would therefore have a cost in respect of the home of $25.

Assuming that the winner lives in the property as their principal residence, the property’s low cost is unlikely to cause adverse tax consequences. If the winner eventually sold the property, the winner would claim the principal residence exemption to shelter any gain upon disposition. Should the winner be unable to live in the property as their principal residence, however, and should the winner decide to sell, the winner would incur a taxable capital gain on the entire value of the property, not only the increase in value since acquisition.

Given the potential adverse tax consequences of this contest, one hopes that it is simply a marketing ploy designed to finally find a buyer for the home. News reports do indicate that the house remains on the market and that should the house sell before the contest concludes, all entries will be refunded. This contest may simply be a unique method of advertising the real estate listing. Should the woman intend to proceed with on the contest, however, one hopes that she will obtain appropriate tax advice before following through with a scheme that could see almost half of the value of her home being paid in taxes.

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