What is Shadow Flipping?
When a property is resold two or more times without changing title, it is called Shadow Flipping. This has been identified in the Toronto and Vancouver markets as a problem. Shadow flipping is a legal, albeit potentially unethical behaviour.
The CRA is analyzing approximately 3,000 cases of shadow flipping transactions in Toronto to determine whether profits from such sales should be taxed as business income or as a capital gain.
When you sell real property at a profit you have to pay capital gains taxes. Capital gains is on only 50% of the profit, significantly lower than the tax rate for business income. The taxes on business profits, however, can be much greater.
Shadow Flipping by Real Estate Agents:
Realtors are prime to involved in shadow flipping. They are in a position to find multiple investors for the same property in order to get commission of all the contract sales. Each intermediate buyer also makes a profit.
A Generic Example of How it Works
- A real estate agent finds homeowners (John and Judy) who are willing to sell their property for $800 thousand at a commission rate of 3%. This would net the sellers/buyers agents $24 thousand in commissions. When John and Judy sign the purchase/sale agreement they sign agreeing to an “assignment clause”.
- Bill signs agreement to purchase the home for $800 thousand. His real estate agent will get ½ of the $24 thousand commission unless he is also the listing agent.
- The agent then locates another buyer (Sam) who agrees to buy the contract for an extra $200 thousand. The agent will get $10 thousand from Bill for arranging the deal.
- Then the agent finds a third buyer (Mary) who is willing to buy the property for an $1.2 million. The agent will get $10 thousand from Sam for arranging the deal.
- The title to the property goes directly from John and Judy to Mary. Neither Bill or Sam incur transfer expenses or have to pay land transfer taxes.
- John and Judy get $776 thousand, Bill and Sam each get $190 thousand and the buyers real estate agent gets a commission of $32 thousand instead of $18 thousand. Mary pays $1.2 million for the home that John and Judy sold for $800 thousand.
What Does it All Mean?
In a nutshell, the real estate agent uses his/her knowledge of what John and Judy are willing to accept and what Mary is willing to pay and extracts as much out of the difference as he/she can. The agent earns a commission on each assignment (or sale).
The two intermediate buyers avoid the costs of the transactions, as they never take possession of the property.
Everybody wins except for the original owners of the property and the end buyer. The original owners don’t get as much as they can from the property and the end buyer pays way more for the property than if she had purchased it from the owners.
Transactions in both Toronto and Vancouver have come under the scrutiny of the Canada Revenue Agency as these locations have seen the most prevalent use of the Assignment Clause and Shadow Flipping.
The Globe and Mail has a good visual representation of Shadow Flipping.