The Development of Duplexes
Due to the affordability compared to single-family homes, duplexes have become more popular than 10 years ago. Since 2018, duplexes have also been permitted on most of Vancouver’s single-family zoned properties. With the limited supply of available land, developers are taking on more duplex projects and home builders are beginning to add on land development on top of their everyday responsibilities. This article will discuss some common accounting and tax issues faced by a developer during a duplex development project.
Consider a hypothetical developer we’ll call ABC Company (“the Company”), which is a local home building and land developer in Vancouver, BC. The Company recently purchased a residential property with land and building with the intention to subdivide and develop a new duplex. ABC Company will sell only one unit of the duplex to a third party and hold the other unit for the benefit of its shareholder’s sister after the project is complete.
CAPITALIZATION OF COSTS
Under Accounting Standards for Private Enterprise (“ASPE”), the following types of costs are considered acquisition costs, construction costs or development costs and can be capitalized to the cost of the acquisition and development for the property that will be sold to the third party:
- Direct construction or development costs
- Overhead costs that are directly attributable to the construction or development activity, this includes direct labour, and subcontractor costs
- Carrying costs directly attributable to the construction or development activity. Including:
- Interest and bank charges
- Property taxes
- Incidental revenue or expenses derived from the property under development prior to substantial completion or readiness of use. Once again, this includes:
- Interest income
- Expense recoveries
- Bank charges
The tax treatment to costs of a construction period is generally similar to the accounting treatment. Costs that are not attributable to the period of construction are deductible when calculating the taxable income of the seller (e.g., landscaping costs, general and admin expenses, accounting and bookkeeping expenses).
The acquisition and development costs incurred on the property that is going to be sold will be recorded as Property Under Development (“PUD”). The acquisition and development costs incurred on the property that will be kept as personal use by the sister will be recorded into a due from related party account as these costs are not costs for the Company but instead the shareholder’s sister. When the project is complete, the cost to build for the sister will be collectible as a build cost plus any additional construction management fee that ABC Company decides to charge for the build.
ACCOUNTING FOR SALES TAXES – UNIT FOR SALE
There are a few instances where Goods and Services Tax (“GST”) will need to be accounted for.
First of all, when the land is purchased, there will be GST on various costs such as legal fees and conveyancing fees. There will also be GST paid on costs incurred during the construction and development phase of the project. The costs should be capitalized to the property under development at the gross amount before GST. GST paid on costs related to the unit that will be sold to a third party will be recovered through claiming input tax credits (“ITCs”).
When the unit is developed and sold (assuming no one has stayed or rented out the unit), GST must be charged on the sale and remitted to the CRA.
ACCOUNTING FOR SALES TAXES – UNIT OWNED BY SISTER
ABC Company cannot technically claim ITCs on the GST that is paid for the build of the sister’s property as those are not expenses to the Company. The Company would charge back the GST they paid during the build of the sister’s property back to her. This should be recorded as an amount receivable from the sister. When the build is complete, ABC Company will also charge a management fee for the build and must charge GST on that. This GST collected from the sister would have to be remitted to the CRA. The sister would be out the GST she paid without being able to claim any ITCs as it is for personal use.
ALLOCATION OF PROCEEDS
Taxpayers normally allocate the proceeds between land and building based on the terms in the purchase and sale agreement.
BUSINESS OR CAPITAL
Generally, one of the major tax questions about a real property disposition was whether it would give rise to regular business income or capital gain. The distinction is important because business income (or loss) gets included in income at 100%, whereas a capital gain (or loss) is only included in income at 50%. Since ABC Company is a real estate developer which purchased the property with the intention to make a profit from the sale of the duplex, any gain realized on the sale usually will be taxed as business income.
When a reasonable reserve in respect of the portion of the proceeds of sale that is not due until after year end, a discretionary reserve is allowed in calculation the seller’s income for the year of sale. There are some limitations around the period for which a reserve can be claimed and whether the seller is eligible to claim the reserve. Please contact your tax advisor to ensure your eligibility to claim the reserve.
CHANGE IN USE
A change in use of a real estate rental property to personal use (i.e., principal residence) may constitute such a change in use, which would result in a deemed disposition at the fair market value of the property. An election is available to postpone the recognition of the accrued capital gain on the deemed disposition if certain conditions are met. If the election is made, the principal residence designation will be available for up to four of the earlier years in which the property was used for business. The CRA may accept a late election if no depreciation has been claimed on the property.
Other things to consider
PROPERTY TRANSFER TAX CONSIDERATIONS
In BC, when you purchase or gain an interest in property that is registered at the Land Title Office, you are responsible for paying property transfer tax and filing a property transfer tax return as the name on the title of the property will be changed to the name of the new owner(s).
Property transfer tax is based on the fair market value of the property (land and improvements) at the date of registration with the Land Title Office.
The property transfer tax rate is:
- 1% on the first $200,000
- 2% on the portion of the fair market value greater than $200,000 and up to and including $2,000,000
- 3% on the portion of the fair market value greater than $2,000,000 and
- If the property is residential, a further 2% on the portion of the fair market value greater than $3,000,000 (effective February 21, 2018).
As such, under the hypothetical example above, there will be property transfer tax payable by ABC Company on the purchase of the property. When the units are developed and sold, there will be property transfer tax payable by the individual who purchases the completed unit when ABC Company sells.
BILLING FOR COSTS OF EACH PROPERTY
- Where possible, should have vendors, suppliers, and tradesmen invoice each property separately. Each invoice should be clearly identified which property is being billed (by address/PID #)
- It may not be practical for each supplier or tradesmen to invoice each property separately. In this case, the invoice should still separate totals out for each property where possible.
- If it is not possible to separate totals out by property on the invoice, then one way to separate the costs of the projects might be to allocate the total cost per the invoice by the square footage of each property.
- When having the legal team draft the bare trust agreement, it is important to have it drafted before the initial property is purchased, and to specify in the agreement who will have the right to which property once subdivided. For example, should mention that ½ will be owned by sister and ½ will be owned by ABC Company, and distinguish which will be which by using street names and directional language as there will only be one legal title and one PID before subdivision.
The information presented above is not meant to be a comprehensive discussion of the accounting and tax reporting requirements for incidental revenues and expenses. If you have any questions regarding incidental revenues and expenses, please visit our Real Estate & Construction page on our website or contact us directly and we can put you in touch with the right advisor to help you and your organization succeed.
 The distinction between whether a transaction is on account of business or on account of capital is important because business income gets included in income at 100% whereas capital gains are only included in income at 50%.