Are sales and renovations of used residential houses GST/HST exempt?
The common belief that the sale of a used residential house is always exempt from the Goods and Services Tax / Harmonized Sales Tax (GST/HST) is not absolutely correct. “Used residential house” is not a defined term in the Excise Tax Act (ETA). Thus, there is no GST/HST exemption on the sale of a used residential house.
Now, before you contact me to tell me I am wrong, please continue reading.
There is, in fact, an exemption that applies to the sale of a residential complex (“residential house”) by a person who is not a builder of the property in question. “Hold on,” you say, “that’s the same thing, right?” Well, not exactly. For the most part, used residential properties are sold by house owners, not builders, but this is not always the case – especially where a person buys a house to renovate and resell or “flip”.
The exemption in the ETA applies to the sale of a residential complex by a person other than a builder. For GST/HST purposes, a builder is not necessarily a construction worker in a hard hat. A person who does a substantial renovation to a house for the purpose of resale is a builder. If a handyman buys a used house to renovate and sell for a profit, the sale of that refurbished house will not be exempt if the handyman is deemed to be a “builder” for GST/HST purposes.
I know what you’re thinking: “I don’t have to worry about this because I’m not a builder. I have a day job that has nothing to do with construction.” But keep in mind that the legislation is designed to create a level playing field between those who dabble with house construction on the side and full-time builders. The definition of builder does not focus on a person’s specific experience or occupation, but rather it relies on the actual work done on the property. You are deemed to be a builder if you completed a substantial renovation.
Builders and substantial renovations
A “substantial renovation” of a residential complex is a renovation or alteration of the whole or part of a building…to such an extent that all or substantially all of the building or part…that existed immediately before the renovation or alteration has been removed or replaced.
A building that is substantially renovated and that, after the renovation, is or forms part of a residential complex is treated as a new house for GST/HST purposes. As a result, the sale of the renovated house is subject to GST/HST under the same rules and conditions as a newly constructed residential complex.
When does renovation work cross the “all or substantially all” threshold and become a substantial renovation? The definition of substantial renovation sets out three key requirements:
- all or substantially all
- of the existing building
- must be removed or replaced.
Requirement 1: all or substantially all
How much of the building is being renovated? The Canada Revenue Agency (CRA) interprets “all or substantially all” to mean at least 90 per cent.1
Any fair and reasonable method is acceptable for determining whether 90 per cent of a building has been renovated. The following are typical methods:
- the square footage of floor space of the areas renovated compared to the total floor space of the building;
- the square footage of floor and wall space of the areas renovated compared to the total floor and wall space of the building; and
- the number of rooms renovated compared to the total number of rooms in the building.
This requirement is based on the actual physical renovations to the building. Neither the cost of the renovations nor the fair market value of the improvements made is an acceptable basis for determining whether the all or substantially all requirement is met.
Only habitable areas of a building should be taken into account when determining whether the building has been substantially renovated. Non-habitable areas are typically ignored in the calculation and include:
- garages
- parking areas
- crawl spaces
- unfinished attics
- furnace rooms.
But what constitutes a habitable area of your house? What about a partially finished basement? At what point would it be considered habitable? Many subjective factors apply to the all or substantially all determination. A review of those factors is beyond the scope of this article, but the best starting point is to perform calculations on the assumption that partially completed rooms do not qualify. If you fall short of the 90 per cent threshold on that basis, then look at partially completed rooms and other factors to try to reach the threshold.
Requirement 2: Of the existing building
According to the definition, it is the “building that existed immediately before the renovation or alteration was begun” that must be substantially renovated. Additions to the existing building generally are not taken into account in determining whether there is a substantial renovation.
Consider, for example, a house renovation that consists of 82.5 per cent renovations to the existing structure (1,650 sq. ft / 2,000 sq. ft) with a significant new 2,000 square foot addition. The new addition brings the total square footage of the house to 4,000, with renovations and the new addition equaling 91 per cent (1,650 + 2,000 / 4,000). The 2,000 square foot addition is ignored entirely for the calculation; only 82.5 per cent of the existing structure is considered for the substantial renovations.
Notwithstanding the above, where the mathematical calculation may lead to the conclusion of a non-substantial renovation, the optics alone may lead the CRA to conclude otherwise. When determining if there was a substantial renovation, always consider the risks of the CRA disagreeing with your determination.
Requirement 3: Must be removed or replaced
The third requirement addresses the type or nature of the renovations required to satisfy the definition of substantial renovation. According to the definition, at least 90 per cent of the existing building must be removed or replaced, excluding the foundation, external walls, interior supporting walls, floors, roof and staircases.
Although the excluded elements may be ignored in determining whether there is a substantial renovation, under some circumstances removing or replacing excluded elements may be considered in determining that a substantial renovation has taken place.
A typical renovation project that would normally constitute a substantial renovation would essentially result in the complete gutting of the inside of the house back to the foundation and supporting walls. More specifically, the renovation would result in:
- removal of drywall and some interior walls;
- replacement of floors, kitchen counters, cabinets and other fixtures; and
- replacement or upgrade of heating, electrical and plumbing systems.
There is much subjectivity in determining if something has been removed or replaced for the definition of substantial renovation. General repairs do not qualify and should not be factored into the substantial renovation. For example, patching drywall, painting surface areas, sanding a hardwood floor, or adding varnish or a plastic coating would not qualify as removing or replacing.
Case by case and common sense
The determination of whether a renovation is substantial in nature can result in the recharacterization of a used house into a new house. Every house renovation is different; an independent review of each renovation, applied with common sense, is required to determine if there was a substantial renovation.
Substantial renovation: now what?
As discussed above, the GST/HST exemption for the sale of a residential complex applies only if the vendor is not considered a builder. Where a substantial renovation has occurred, the vendor or owner will be deemed a builder, subjecting the sale of the property to GST/HST.
Since the sale of a substantially renovated property is treated the same as the sale of a new house, the person flipping the house may also be entitled to claim input tax credits for GST/HST incurred on all related costs.
Non-substantial renovation: am I okay now?
Where a renovation or alteration is made to a residential real property and the property is not substantially renovated, the vendor is not considered a builder. Thus, the sale of the property generally qualifies for exempt status.
Since GST/HST is a value-added tax, an exempt sale of a non-substantial renovation results in no tax applying to the additional property value resulting from the non-substantial renovations. To correct this problem, the ETA imposes a special self-supply rule to tax part of the value added under the renovation. The rule effectively bridges the gap between adding some value to the property and completing a substantial renovation.
Under this self-supply rule, a person who completes a non-substantial renovation is subject to GST/HST on the value of the renovation, calculated as follows:
The costs that would be included in the adjusted cost base of the property less:
- the original acquisition cost of the used residential real property;
- the interest and the costs of other related financial services; and
- the costs of renovations that were already subject to GST/HST.
As a result of this calculation, the self-supply of GST/HST generally applies to the labour component of such a renovation.
Now you know, but knowing is only half the battle
This article will not make you an expert on GST/HST and sales of new and used residential houses. The purpose is to provide an awareness that any renovation of a residential property (including a cottage) should be followed up with professional guidance on the potential GST/HST implications. As a further incentive to ensure you are properly following the rules, Budget 2019 proposes spending $50 million over five years, beginning in 2019-2020, to create four new dedicated real estate audit teams (in British Columbia and Ontario). The focus of these teams will be:
- reporting of principal residence sales;
- capital gains from the sale of other real estate;
- income from real estate flipping; and
- commissions and appropriate remission of HST on new residential properties.
In my 22 years of practice I have seen many unintended GST/HST reassessments related to renovated houses and cottages. The best risk management is to seek professional advice. Contact your Baker Tilly advisor for help.
1 The 90 per cent threshold is an arbitrary number determined by the CRA. The courts have allowed a threshold lower than 90 per cent to be considered all or substantially all in some circumstances.
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