June 19, 2013:
With a number of regionally specific real estate markets softening, employers who relocate employees domestically within Canada, are likely to have already, or will soon experience a transferee that is in a loss on sale position. This means that the employee is unable to sell his/her home for the same price at which he/she purchased it. Before discussing further, we should review the three major types of loss positions in descending order of gravity.
Loss on Sale vs. Original Purchase Price and the cost of capital improvements: If a relocated employee originally bought a home for $300,000 and put capital improvements into the home of $25,000, but he/she is only able to now sell the home at $310,000, then the loss is $15,000. This can happen even in good real estate markets. For instance, if an employee just recently bought a home, made capital improvements, and then is relocated, they may not get dollar for dollar out of his/her improvements, especially if those improvements were not specifically made to a kitchen or bathroom.
Loss on Sale vs. Original Purchase Price: If a relocated employee originally bought a home for $300,000, did not make any capital improvements, but is only able to sell the home at $275,000, then the loss is $25,000.
“Under Water” or negative equity position: this is the most serious of the loss scenarios. In this case, the employee in question once bought the home at $300,000 and got a mortgage of $255,000. By the time of the relocation, the mortgage has been paid down to $250,000. So the theoretical equity in the home, if sold at the original price of $300,000 is $50,000. However, the employee is unable to sell the home for any more than $240,000. In this case, even with the company paying the costs of real estate commission and legal fees, the employee cannot close the real estate transaction without coming up with $10,000, in order to pay back the mortgage company a full $250,000.
Recap regarding Canada Revenue Agency (CRA) and Loss on Sale Protection
CRA allows an employer to cover $15,000 of loss on sale in a tax free manner. If an employer covers any loss amount over $15,000, then half of every dollar covered over $15,000 will be taxable.
Example #1: Amount of Loss covered = $15,000. Employer pays employee $15,000, and it is not considered income.
Example #2: Amount of Loss covered = $30,000. Employer pays employee $30,000. The first 15,000 is not considered taxable income. The actual taxable income attributable to the employee is $7,500 (half of the remaining $15,000).
The employee will have to obtain proof of purchase price and provide to the employer for its records.
We will now discuss Loss on Sale including Capital Improvements.
First, it should be noted that covering loss on sale including Capital Improvements is a generous practice and is not covered by most employers. The other challenge is that what an employee feels is a capital improvement very often is not a capital improvement. CRA does not do a great job of describing capital improvements, but a renovation of a kitchen or bathroom is very clearly a capital improvement. Replacing broadloom carpet with hardwood flooring is a capital improvement. Creating aesthetic improvements such as painting is not a capital improvement unless it is part of the renovation. If, as an employer you are considering covering loss on sale including capital improvements, you should be very clear in your policy as to what constitutes a capital improvement and what does not. Many companies have a policy of amortizing the value of the capital improvements over several years i.e. they pay 100% in year one, 80% in year two and so on up to year five. Your relocation provider can help you with this.
The employee also must have proof of the cost of the improvements, or they should not be covered, because they will not be defensible to CRA, if the corporation wishes to make the coverage non-taxable.
Current Real Estate Markets: All Points has seen loss positions most frequently, recently, in Vancouver. However, with some recent and general softening in many real estate markets, we have also seen loss positions in the condo market in Toronto, Edmonton, and in smaller secondary and tertiary centers. We have also seen loss positions in cases when employees bought homes in new developments within the last few years, and paid for upgrades, such as better countertops, and now the developer (who has not sold out the development) is dropping prices for new customers.
What should companies do right now?
Regardless as to whether you relocate employees with a Guarantee Home Sale program or if you relocate employees and only have a defined benefits policy or a policy wherein employees are reimbursed for costs up to a budgeted amount, you should prepare for potential loss on sale right away. Employers should start to direct their employees’ marketing, if they have not done so already. This has always been the case with those relocated under Guarantee Home Sale programs, but now it is equally important for employees who are just covered for their closing costs. If an employee “tests the waters”, trying to market the home for too much money, because they are trying to recoup losses, then the employer is likely to end up paying extra costs for temporary living, trips home and ultimately have an unproductive employee. Employers should change their policies to include ordering an appraisal to set list price parameters to ensure that employees are marketing their homes as aggressively as possible.
Employers should also decide upon their loss on sale strategy right away. Will you get involved? What type of loss will you cover, and how much? How will you handle employees who cannot buy a home in the destination city, because they cannot sell their home in the origin city? Being prepared with the answers to these questions will help you create defined positions in your relocation policy, and ultimately save the company money, and create confidence around relocation.