Are you a residential real estate developer that has had to turn new-sale inventory into rental in the last four years? Or are you a multi-family property developer that also has a residential rentals division?
We regularly help development companies who build properties for rent or convert inventory to rentals to wait out fluctuations in market conditions. Once a tenant moves in, a GST/HST “Event” takes place that can be costly if not handled properly.
In Canada, changing demographics and economics are also driving a considerable increase in the number and value of purpose-built residential rentals in the multi-family sector. This applies equally to single family homes, multi-family homes, and multi-purpose high density properties and everything in between.
We have also helped out clients in many situations in the last several years where builders cannot sell a single-family home, duplex, fourplex, condominiums, etc., and they are then forced to generate some cashflow by converting to a long-term residential rental property. Normally these occupancies are for at least 1-6 months and longer and in so doing, a builder-landlord triggers a “GST/HST Event” and is required to “self-assess GST/HST” on the fair market value (“FMV”) and remit that to the Canada Revenue Agency (CRA).
The long-standing rule about the “Event”, requires a builder-turned landlord, to “self-assess” GST or HST (similar rules apply for Quebec sales tax) on the FMV of the converted property. The Event occurs at the later of the time the building is generally 90% complete and the time that the first tenant moves into the property. In the case of multi-unit properties, the Event occurs in respect of the entire property for all units. The Event occurs regardless of whether the builder had an “intent” to sell the property, but there are certain exceptions such as a “rent-to-own” arrangement with the tenant-purchaser.
For example, take a 100-unit multi-family property in Edmonton, with a cost to construct including land, of $ 25M that is 90% complete (as to cost) on August 31. On September 1, the builder-landlord signs a 12-month residential tenancy agreement with a single tenant that moves into one of the apartments. The tenant will move in on October 1, 2022. We have seen situations where occupancy permits have been issued when the building is overall, only 80% complete and the first tenants move in; however, the Event will not trigger until the property is 90% complete (interpreted to be “substantially complete”) and therefore GST/HST doesn’t apply until that time.
The builder has a professional real estate valuation firm on retainer and engages them to prepare an appraisal report for purposes of the Event, effective October 1, 2022, when the first tenant moves in. The appraiser arrives at a final value of $30M based on 100% completion of the proerty using one of three well-established approaches to value, used by accredited real estate appraisers. Assuming the “income approach” establishes the most accurate reflection of FMV, the builder might calculate the GST/HST (GST at 5% in this case) as $1.5M ($30M x 5% – AB) and then report and remit that on its October 2022 monthly return.
Unfortunately, this builder has grossly over-calculated the GST to remit to CRA for a variety of reasons, but if they discover this error within four years of October 2022, they may be able to correct the error with the CRA. However, let’s assume that the builder instead engaged Achen Henderson CPAs with deep experience on this issue instead. From the outset, this builder could have saved $150,000 and possibly more, notwithstanding that the builder is eligible to claim a rebate up to 36% of the GST that is self-assessed due to the Event, based on the value per door & 1-year leases.
When a builder-landlord is subject to the Event and reports and remits the GST/HST, they are eligible for a special GST/HST rebate for residential rental properties where the total FMV of each unit, does not exceed $450,000. They are eligible to claim this rebate within two years of the date that the Event occurs and the GST/HST becomes due; however, most builders should file the rebate at the same time with the same return when the GST/HST is due.
What we have seen too often is that the self-assessment is either failed to report the Event or is not completed until after the two-year rebate period expires. In such cases, the builder has been assessed by CRA at the time of the Event (i.e. 2+ years earlier) and is then not eligible for the rebate since the two-year deadline has passed. In these cases, there is typically a late filing penalty of up to 4% and then arrears interest of between 6% and 10%, depending on how much time has elapsed.
Let’s assume our builder-landlord went with their $1.5M GST calculation, and then files the rebate at the same time as the GST is remitted on their October 2022 GST/HST return. Let’s also assume that each of the 100 units is valued at less than $350K, where the rebate begins to be reduced pro-rata until the $450K maximum is reached for one or more units.
Based on the FMV of the entire complex of $30M and $1.5M in GST to be remitted on the October return, our builder will be entitled to a GST/HST residential rental property rebate of $540K, equal to 36% of the $1.5M of GST. This would leave our builder a total GST bill of $960K ($1.5M – ($1.5Mx.36)). If we instead go with Achen Henderson’s calculation, they would have remitted $91K less to the CRA.
Our views and takeaways
We have helped many builders who have run afoul of these rules resulting in audit assessments along with penalties and interest. There has been substantial CRA audit and review activity directed to builders who incorrectly report the building and conversion of rental properties. Fortunately, more and more builders are now turning to accredited real estate valuation firms that have deep experience with this issue, working hand in hand with “Event-experienced” tax professionals like Achen Henderson CPAs.
We have recently learned of some CRA auditors, assessing an automatic 25% gross negligence penalty for builders’ failure to obtain a professional real estate appraisal report. It is our view that this is generally inappropriate and is an excellent reason to engage an experienced tax professional along with an appraisal specialist to help you navigate these audits and reviews, along with an accredited and “Event-experienced” real estate appraiser that is used to preparing valuation reports for CRA purposes and defending their reports’ FMV.
Not so complicated right? At Achen Henderson, we can help you to take the complexity out of the “GST/HST Event” and all your sales and indirect tax obligations. Call us today for help getting your sales tax collection and reporting right, so that you can rest easy by ensuring your business is not offside with these rules where you operate across Canada.