Too often, we hear customers say, ” I thought that if I didn’t claim taxes on the construction costs of a new rental property, I wouldn’t have to self-assess taxes,
or ” I’m not registered for GST/HST and QST, so self-assessment tax remittance obligations don’t apply to me “.
These are false beliefs!
Let’s face it, there are still a number of misperceptions and beliefs about the rules governing self-assessment of taxes. Assuming that the rules governing real estate are among the most complex when it comes to sales taxes, it would be wise to always consult a specialist when taking part in a real estate transaction.
This publication is therefore intended as a reminder of important concepts for real estate enthusiasts and all professionals who work with their clients in this field.
SELF-ASSESSMENT IN TAXES
Whether you’re dealing with a newly-constructed rental residential complex, a substantially-renovated rental residential complex, or the construction of an addition to a rental residential complex, the self-supply (“self-assessment”) rules set out in the Act respecting the Excise Tax (“ATA”) and the Act respecting the Québec Sales Tax (” AQST “) will apply, even if you have not claimed the taxes paid on the construction costs of the building..
These rules were put in place to prevent builders from gaining an advantage over buyers when acquiring a new residential building. Simply put, when a person (incorporated company, partnership, individual, trust, non-profit organization, etc.), referred to as a “builder” as defined in the Act, constructs or causes to be constructed a residential rental property, it is deemed to have sold and repurchased the property at its fair market value (“FMV”) at the time a unit in the property is first rented.
These rules apply, among others, to anyone who builds, has built or substantially renovates a residential building for the purpose of renting it out for residential purposes. If an immovable located in Quebec is sold upon completion of the work without there having been a transfer of possession or use of a dwelling by a first residential tenant, then this sale would be subject to GST and QST.
Self-supply tax becomes payable on the latest of the following dates:
- The day the construction work is substantially completed (generally 90% complete);
- The day possession or use of a unit in the residential complex is transferred to an individual for occupancy as a place of residence.
For GST/HST and QST purposes, tax authorities consider the work to be “substantially completed” when construction of the building is completed to the point where an individual can reasonably inhabit the premises (generally 90% or more). Remaining minor repairs, adjustments and improvements do not preclude the use of the dwelling as a place of residence.
Therefore, the date of substantial completion (90% or more) is a matter of fact and circumstance that must be carefully assessed. The assessment of the degree of completion is not made solely on the basis of project costs, but on the basis of the actual time of completion of the work carried out on the building.
The concept of FMV is defined as the highest price that can be obtained on an open, unrestricted market between parties acting at arm’s length and under no compulsion to act. Therefore, when determining the FMV of real estate (land and building), we recommend obtaining an appraisal from a chartered appraiser for self-assessment purposes, in order to be able to justify the value of the property to the tax authorities. Many people use the value established in an appraisal report for financing purposes. However, this report aims to determine the value at a date prior or subsequent to the time of self-assessment, which is not adequate. Also, this financing appraisal may result in a higher FMV than the building’s value at the time of self-assessment, which could have negative tax consequences for the builder.
Furthermore, it is important to note that municipal valuation is not a preferred value when determining FMV for self-assessment purposes. Furthermore, greater vigilance should be exercised with regard to the valuation method based on construction costs, which is advocated by some. Jurisprudence has on a number of occasions adopted this method for determining the FMV of a building in a primary market context, but be careful to consider all costs, including indirect costs, ancillary expenses such as financial, management, advertising, promotion and development costs, as well as the market value of the land at the time of self-assessment; not forgetting the value of any type of obsolescence to be taken into account. An expert real estate appraisal report is strongly recommended even if you wish to use the valuation method based on the actual costs of the construction project, considering that the administrative position of the tax authorities seems to indicate that the actual construction cost method represents a cost price and consequently does not constitute the FMV of the building.
TAX REFUNDS
Where self-assessment is required and the builder is registered for GST/HST and QST, the builder is entitled to claim all taxes paid on all costs relating to the building construction project (up to the date of self-assessment), as an input tax credit (“ITC”) and input tax refund (“ITR”). In effect, a builder who carries out a major renovation or builds a new building or an addition to a new residential rental property is entitled to claim the taxes paid on the acquisition of the land and the total construction costs of the residential property. This avoids double taxation of project taxes when self-assessing applicable taxes.
The registrant is free to claim ITCs and ITRs as the construction project progresses following receipt of invoices from suppliers, or may defer such tax claims when remitting self-assessment taxes, reducing the cash outflow at the end of the project.
Where the builder is not registered for GST/HST and QST, recovery of taxes paid on construction costs will be possible by filing a general rebate application for a non-registrant, with Revenu Québec (for construction in Quebec), within two years of the date of self-assessment. Generally speaking, we recommend that you file the refund application at the same time as you self-assess taxes on the FMV of the building.
In addition, since taxes are payable on the self-supply, as if it were a “regular sale” of a new building, the builder may be eligible for tax rebates for a new residential rental property, calculated on the basis of the taxes rebated on the self-assessment, in circumstances where the eligibility criteria would be met.
Applying for a tax rebate on a new residential rental property allows the owner to claim up to 36% or 100%[1] of the GST rebated on the FMV of the residential complex (the amount of the rebate depends on the FMV of each unit in the residential complex).
Thus, under the GST system, for a construction project that does not qualify for the enhanced full GST rebate announced by the federal government on September 13, 2023, eligibility for the full 36% GST rebate requires that the FMV of a dwelling not exceed $350,000. The GST rebate then declines when the FMV of a dwelling exceeds $350,000, becoming nil once the FMV before taxes reaches $450,000.
For a construction project eligible for the enhanced 100% GST rebate[1], there is no eligibility ceiling. However, the purpose-built rental property must consist of at least 4 units, and construction work must have begun after September 13, 2023, but before 2031, and be substantially completed before 2036.
The provincial government has not announced any improvements to the QST system. Instead, the eligibility ceiling per dwelling is $225,000. The QST rebate declines when the FMV of a dwelling exceeds $200,000, becoming nil once the pre-tax FMV reaches $225,000.
ATTENTION
Whether you’re an individual building a rental property for the first time, or you’re a seasoned builder accustomed to constructing buildings for resale, but you’ve decided for once to rent out one or more homes before selling, the self-supply rules affect you precisely.
It often happens that people working in the real estate industry are surprised by our conclusions that they need to self-coagulate, even though their personal readings led them to believe that this was not required.
Considering the complexity of the rules applicable to taxes, we recommend that you consult a commodity tax expert to validate your specific situation. For more information, please contact us.
An article from our consumption tax team
[1] Enhanced 100% GST rebate from the federal government for any purpose-built rental property with 4 or more units for which construction work (start of excavation) began after September 13, 2023. See our article on GST Rebate Bonus – Residential Rental Properties – Amyot Gélinas (amyotgelinas.com)
