Author Segal LLP

The Lowdown on Home Appraisals

Buying a home is likely to be the largest single investment you will ever make, and whether it’s your primary residence or a vacation home, you and your mortgage lender, will want to know that the value of the property is in line with the amount you plan to pay.


Preparing for an Appraisal of Your Home

If your house is being appraised, it is helpful to have certain documents available when the appraiser arrives, including:

  • The most recent assessment from your local Municipality Property Assessment Corporation.
  • A plot plan or survey of the house and land if available.
  • The date you purchased the property.
  • A list of personal property that will be part of the sale.
  • Title policy that describes encroachments or easements and any written property agreements, such as a maintenance agreement for a shared driveway.
  • A list of major home improvements and upgrades, when they were done, and how much they cost. Include permits if you have them.
  • A copy of the current listing agreement and broker’s data sheet and purchase agreement if a sale is pending.
  • Information on Homeowners Associations or condominium covenants and fees.
  • A list of proposed improvements if the property is to be appraised “As Complete“.

You don’t need to accompany the appraiser during the inspection, but you should be available to answer questions and point out any improvements.

Make sure all areas of the home are accessible, including the attic and crawl space.

This is where an appraisal comes into play. A real estate appraisal provides an estimate of the fair market value of a property and it can make the difference between getting that mortgage and having the financing fall through.

But there are other reasons you may want to have your home appraised, such as:

  • Lowering your tax burden;
  • Establishing the replacement cost of insurance;
  • Settling an estate or divorce;
  • Satisfying a government agency request, say for tax purposes, or
  • Providing evidence in a lawsuit.

Mortgage lenders require appraisals to ensure that a property is worth the amount they are lending. Then, if a borrower defaults, the lender knows there is adequate collateral to recoup the initial investment.

As the potential buyer, you’ll pay for the appraisal. Costs vary widely, depending on the house, the province, the geographic location and the scope of the report.

Appraisers start by viewing the property inside and out to ensure that it is in a condition that a reasonable buyer would expect. The appraiser looks for any obvious features — or defects — that would affect the value of the house.

Once the site has been inspected, the appraiser employs one of two common methods for evaluating properties that are to be used only as personal residences and not to generate rental income.

Cost Approach

The appraised value is determined by combining the value of the land with the estimated reconstruction cost of the home minus accrued depreciation. This method is most useful for new properties, where the costs to build are known.

The appraiser takes data on local building costs, labor rates and other factors to calculate the cost of building a home similar to the one being sold. The appraisal often sets an upper limit on what price the property could fetch. Such mitigating factors as location and amenities are usually not reflected in the cost approach.

If the appraisal comes in lower than the amount you were planning to finance, the bank isn’t likely to provide the full amount you were hoping for. Depending on your contract with the seller, you may be allowed to back out of the purchase deal or make a lower offer.

You could make a larger down payment in order to secure a mortgage the lender would be willing to extend, but then you risk spending more cash than makes you comfortable. If the appraisal comes in higher than expected, the seller generally does not have the right to raise the asking price.

Sales Comparison Analysis

This method compares the attributes of the home for sale with existing houses in the area that have similar attributes and have recently been sold. No two properties are exactly alike, so the appraiser compares the comparable properties to the home you are interested in, making adjustments to make the comparable homes’ features more in-line with the listed property. The result is a figure that shows what each comparable home would have sold for if it had the same features as the listed property.

Using knowledge of the value of such features as square footage, extra bathrooms, hardwood floors, fireplaces and view lots, the appraiser adjusts the value of the comparable home. For example, if a comparable property has a fireplace and the home you want does not, the appraiser may deduct the value of a fireplace from the price at which the comparable home sold. If the house you are looking at has an extra half-bathroom and the comparable home does not, the appraiser might increase the price of the other property.

This approach is generally considered the most reliable if adequate comparable sales exist.

In most instances when the cost approach is involved, the appraiser actually uses a mix of the cost and sales comparison approaches. For example, while the replacement cost to construct a building can be determined by adding the labor, material, and other costs, land values and depreciation must be derived from an analysis of comparable data.

If you are looking for an appraiser on your own, ask your real estate agent or use the search function on the website of the Canadian National Association of Real Estate Appraisers.

When Expectation Becomes Intention

Owning rental property has long been a popular investment, particularly when losses from the property can be deducted against other income. However, Canada Revenue Agency (CRA) sometimes attacks rental-related expenses and denies the deductions.


The Landmark Cases Stewart v. The Queen.

The taxpayer invested in four condominium units and the investment had no element of personal use.

He incurred losses from the beginning because the purchase was financed almost entirely with debt and he had significant interest expenses. Losses were projected to continue for up to 10 years. The CRA disallowed the losses using the “reasonable expectation of profit” test, arguing there was no source of income. The deduction for interest expenses was also disallowed.

The Supreme Court of Canada ruled that Stewart was entitled to deduct his losses since his rental property lacked any element of personal use and was clearly a commercial activity.

Walls v. The Queen. A limited partnership invested in a warehouse business. The partnership paid service charges, management fees, and 24% annual interest on the purchase price of $2.2 million.

The taxpayers then deducted their share of the losses. The CRA again disallowed the losses based on real expectation of profit but the Supreme Court ruled:

” . . . there was no evidence of any element of personal use or benefit in the operation. Where, as here, the activities have no personal aspect, reasonable expectation of profit does not arise for consideration. Although the respondents were clearly motivated by tax considerations when they purchased their interests in the partnership, this does not detract from the commercial nature of the storage park operation or its characterization as a source of income.”

Over the years, a number of special provisions have been introduced into the Income Tax Act to limit taxpayers’ ability to claim rental losses. For example:

Regulation 1100(11). Under this provision, a rental loss can’t be created or increased by claiming the Capital Cost Allowance (CCA). All rental properties owned are pooled for purposes of this regulation. The result is that a taxpayer can only claim the CCA if total rental revenue exceeds total rental expense, and then, only enough to reduce income to zero.

Subsection 13(21.1). When land and buildings are sold together, any terminal loss on the building is reduced to the extent of any capital gain on the land. So, you can’t manipulate the amount of the deduction of a terminal loss at 100% and report a capital gain taxable at 50%.

The tax agency also has a long history of denying rental losses due to a taxpayer having no “reasonable expectation of profit”. But in two Supreme Court rulings described in the right-hand box, the court struck down the expectation of profit test and said the tax agency should use a two-pronged approach to losses:

    • If the taxpayer’s activity is “undertaken in pursuit of profit,” the income is deemed to be from a business or property and losses will be allowed. Where there is no personal element, the CRA shouldn’t second guess a taxpayer’s business decisions.


  • If the enterprise has a personal element, the tax auditors must consider whether the taxpayer had an “intention to profit” from a business operated in a “sufficiently commercial manner.” (Stewart v. The Queen, 2002, SCC 46 and Walls v. The Queen, 2002, SCC 47).

While “sufficiently commercial” wasn’t defined, all circumstances surrounding the activity should be considered in making that determination.

So Finance Canada added a more restrictive and onerous test aimed at eliminating many real estate investments (including tax shelters). A loss on a property is only allowed if it is reasonable to assume that the taxpayer will realize a cumulative profit from the property during the time the taxpayer has held, or can be reasonably expected to hold, the property.

In addition, the expected profit has to come from renting the property. It can’t come from a capital gain due to the increase in value of the property. The legislation specifically provides that there is no source of income from capital gains, and therefore no profit from a capital gain.

The test is to be applied every year a loss is deducted. On the other hand, if the property starts to make a profit – even if there previously had been no reasonable expectation of profit – the profit will be taxable in the year it is made. (It doesn’t appear a taxpayer will be allowed to go back and amend prior years’ returns to deduct losses not previously deductible.)

If you have leveraged investments in real estate where the rental revenue isn’t expected to exceed the expenses for many years, consult with your advisor and review these four points:

1. Have there been profits or losses in the past?

2. How does your training and background affect the situation?

3. What is your profit intention?

4. Is there any personal element? For example, do you or family members use or reside on the property?

Claim a Capital Gains Reserve and Defer Taxes

lores_capital_gain_kkCapital gains on sales of property other than your principal residence can be a significant tax cost in the year of the sale.

Whenever you dispose of capital or other property, principal residence aside, you need to report a capital gain when the sale price is more than the purchase price. When the property’s value is high the capital gain can add a significant amount to your tax liability. However, with some tax planning you can either defer or reduce the amount of capital gains.

Where you have a capital gain on the sale of property, you may be able to defer part of the capital gain by claiming a reserve. You may claim a reserve in cases where you receive payment of capital property over several years. The reserve allows you to defer payment of taxes on capital gains until the full proceeds are received.

For example, you sell a capital property for $100,000 and the terms of the sale prescribe that the buyer will pay $20,000 initially and the remainder in equal instalments of $20,000 over the next four years. In this case you may be able to claim a reserve.

Generally you can claim the reserve on the disposition of capital property unless you:

  • Were not a resident of Canada at the end of the tax year of the sale of at any time in the following year;
  • Were exempt from paying tax at the end of the tax year or at any time in the following year;
  • Sold the capital property to a corporation that you control in any way.

Calculating the Reserve

If you are eligible to claim a reserve, the general formula for calculating it is:

The total gain (in excess of cost) divided by the total proceeds of the disposition multiplied by the amount payable after the end of the year.

Using our example, and assuming the original cost of the property was $60,000, the reserve that can be claimed in the year of the sale is calculated as:

$40,000 (excess of original cost) divided by $100,000 (sale price) multiplied by $80,000 (amount payable in the following year, for a reserve of $32,000. [$40,000/$100.000 X $80,000 = $32,000.]

When you report the capital gain on your tax return, you calculate it as proceeds of disposition of capital or other property minus the cost of the property, which is the full $40,000. Then you deduct the reserve for the year.

The remaining amount is the portion of the capital gain that you need to report in the year you made the sale. The reserve is reported on the Form T2017, Summary of Reserves on Dispositions of Capital Property.

In the following year you will have to include the reserve in the calculation of capital gain for that year. That means you will have to include the $32,000 reserve when you calculate capital gains on the income tax return for the year after the sale. You will have to calculate a new reserve for that year.

20 Per Cent Rule

For capital and other assets disposed after November 12, 1981, reserves are permitted only for a limited number of years. The limitations are the following:

Sale of capital assets: Generally, the maximum period over which most reserves can be claimed is five years. However, the rules specify that in any year the reserve should be a lesser of the amount calculated using the general formula above and 20 per cent of the total capital gain in the year of disposition, 40 per cent of the capital gain in the following year and so on. As a result, in each year the reserve is claimed, the general calculation and the 20 per cent rule must be compared.

In other words, you do not have to claim the maximum reserve in a tax year. However, the amount you claim in a later year cannot be more than the amount you claimed for that property in the previous year.

Note: Transfers to your child of family farm property, family fishing property, and small business corporation shares, as well as gifts of non-qualifying securities have an identical rule with a 10 year period.

Sale of ordinary assets resulting in business income: If you disposed of an asset in the normal course of the business and it generates ordinary business income, the maximum period to claim the reserve is reduced to three years. In this case the reserve will be the prorated portion of the profit that is due in each of the three years.

Reserves that you can claim on disposition of capital property can be a useful tool in terms of tax planning. Tax deferral and reserves can be used to reduce the overall tax on a large capital gain transaction as individual tax rates increase with the amount of income earned. However, if the proceeds are deferred over a long period of time the taxes may be due before the money is received. Make sure you have enough money to pay the taxes.

If you sell a capital or other property for a capital gain, consult with your accountant about making sure that you are taking advantage of all the possible tax planning points.

Maintain Liquidity by Minimizing Credit Risk

Liquidity is critical to the viability of any business, regardless of the industry where it operates.


Shore up Listless Collection Practices

When your business is confronted with some past due accounts, there are several ways to help encourage payment of bills. The first step, of course, is to be sure the invoice contains the due date. Providing incentives for prompt payment will also help. You can offer discounts for payments received before the due date and you can charge interest on late payments. If you apply penalties on overdue accounts, be sure the amounts you charge fall within the provisions of the Criminal Code and the federal Interest Act. When a customer does miss a due date, prompt and courteous contact will generally produce results. This can be done by telephone, mail or fax. Document all your collection attempts by sending written notices and keeping copies. It is important to respond rapidly in case the customer does clear the account so that unnecessary delays in shipping are avoided. Your company’s credit department and the accounts receivable bookkeeper should maintain close communication.

The most extreme method to obtain payment is to stop providing goods or services until you receive full payment. But be cautious. This could damage your company’s relationship with an important customer who provides you with significant business. If it becomes clear that you are not going to be paid, you have three main choices:

1. Write-off the account if you determine that it is not worth spending more time and money trying to collect it.

2. Hire a collection agency. You will have to pay a fee or a percentage of the amount collected. Meet with the agency to discuss its procedures and confirm that the collector will not incur any costs of start litigation without your permission.

3. Take legal action. This is no guarantee of being paid, so before you start litigation try to determine the likelihood of collection. Assess whether the individual has sufficient assets to cover the debt and legal fees.

Simply put, liquidity is the ability of your enterprise to meet its financial obligations, usually with cash on hand or by converting assets to cash. It also entails making sure your business has the financial ability to continue providing goods and services without heavy discounting and collecting your receivables timely with minimal write downs and write offs.

One way to avoid sliding into a liquidity crunch is not to extend credit to customers with little creditworthiness. Your enterprise’s liquidity and survival depends on a steady inflow from timely collected receivables.

Accomplishing that requires taking cautious steps before extending credit and staying on top of collection procedures. (See right-hand box for ways to encourage credit customers to pay on or before the invoice’s due date.)

Credit policies and procedures, however, do not always ensure the cash flow to sustain a business. Without a steady stream of revenue from sales, your business runs the risk of illiquidity and therefore being unable to pay its own debts.

When a customer asks for credit, be sure that the application requires:

1. The names, addresses and phone numbers of at least three companies the applicant has had credit dealings with.

2. The applicant’s bank accounts with branch addresses and account numbers.

With this information, you can start taking action. The next steps are critical to helping ensure your customers stay on track with their payments:

  • Call the applicants’ banks to ask if they are a good credit risk.
  • Verify the applicant’s bill-paying history with the business references.
  • Run a credit check with one of the two main rating agencies in Canada, Equifax Canada and TransUnion Canada.

Staying in Control of Receivables

Of course once you’ve granted credit to a customer, your job is just beginning. Your company’s collections manager needs to constantly monitor receivables and closely monitor slow-paying accounts. Part of that process involves balancing the benefits of extending credit, which will boost sales on paper, against the costs of carrying receivables and perhaps being unable to collect them.

There are tools to help you stay in control. Three of the most critical are:

1. Receivables Ratio. You should hold receivables for the shortest time possible. This boosts the timeliness of payments and maximizes the accounts receivable turnover ratio, or the rate at which you are collecting bills during a given period. To determine the ratio, divide net credit sales by average accounts receivable.

2. Aging Schedule. This gives you a bird’s eye view of your receivables and the due dates. It’s a straightforward way of understanding your collection efforts and highlighting overdue bills. The accounts receivable aging schedule typically includes the name of the creditor, the total due, and the amounts due in the current month, the previous month, the preceding two months and more than 60 days.

3. Average Collection Period. One of the most important measurements is the average number of days it takes to collect a bill. This is the length of time it takes to convert sales into cash and underscores the relationship between accounts receivable and cash flow.

The longer the collection period, the more you invest in accounts receivable. And a long collection period means less cash available for your company’s own needs. Remember your firm isn’t the banker so stop acting as if you are. It will only add to your financial problems if you continue doing so.

To calculate the collection period, divide the number of days in the year by the accounts receivables turnover ratio. Or you can take the average accounts receivable and divide that by the average daily sales (net credit sales/days in a year).

The average collection period is commonly used to compare your success at accounts receivable management to that of your industry peers. It can also be used to analyze your collection efforts across various time periods, and determine how well your customers are doing paying their bills when compared with your credit terms.

These are just some of the tools that let will assist you in controlling and monitoring accounts receivables. Your accountant can help you implement the use of these tools and interpret other ratios, reports and measurements involving credits and collections.

The U.S. Patriot Act and Canadian Data Security

Mention hosting data remotely to most people, and you will hear expressions of various concerns, such as:

  • Data might be inaccessible at times due to Internet failure;
  • Unauthorized people might see the information; orGovernment agencies could gain access to your personal or business data.

lores_DOJ_US_Department_Justice_Seal_Logo_goldAdd the U.S. Patriot Act to the mix and the reactions and anxiety are likely to become even stronger. Many companies and individuals fear that the American law gives the U.S. federal government sweeping powers to look at any data at any time for any reason. Before making a decision to embrace a cloud computing solution that involves hosting data in the U.S., you should separate myth from reality.

First, it is critical to be aware that today’s information technologies make it easy for organizations and individuals to exchange information quickly around the globe. This transborder data flow is becoming increasingly popular as both companies and governments take advantage of outsourcing.

In today’s global economy, suppliers can be located anywhere. Even if a domestic supplier is chosen, it may have offices located in other countries. When a supplier is hired to administer personal information and any parts of its operations, including subcontractors, are outside of Australia, the laws of the other countries may be applicable to information stored or electronically accessible in the foreign country. If a company located in the United States or with U.S. connections is hired, then the U.S. Patriot Act may be applicable.

That legislation primarily extended to anti-terrorism the provisions that originally were used simply to deal with typical criminal investigations. The law permits U.S. law enforcement officials to seek a court order giving them access to the records of a company or individual, sometimes without the suspect’s knowledge. Any organization with a presence in the U.S. or controlled by a U.S. business may be subject to these court orders and compelled to comply with the warrant.

In some circumstances, the law may have made it easier for the U.S. government to gain access to personal data. It did not, however, “fundamentally alter the right of the government to that data in those circumstances,” according to an article written by Jeff Bullwinkel, Associate General Counsel and Director of Legal & Corporate Affairs, Microsoft Australia. In other words, the U.S. government has long had the ability to seek access to personal information in pursuit of legal investigations.

How does the U.S. Patriot Act affect American government access to information that is stored outside of the U.S.? If the data is under the control of a U.S.-headquartered company, the government can use the law just as if the information were stored inside the U.S. If the company is not an American company the U.S. Patriot Act does not apply, although there still are ways the U.S. can gain access to the information it is seeking.

The U.S. has long had many cross-jurisdictional agreements that allow law-enforcement agencies in one country to gain access to data stored in another country. Government agencies in every country at some time have legitimate needs to access information to enforce their nation’s laws. Increasingly, that information is stored in foreign jurisdictions. While different laws and international agreements help facilitate access to this data, both domestic and some foreign laws maintain strong protections.

Deciding where to store your data has become increasingly complex as the options have expanded from storing data on a computer you or your business directly controls to sending the information into the cloud and storing it on some server remotely located anywhere on the globe. Wherever you decide to store information, be certain that appropriate measures are in place to protect that data from unauthorised access.

Take the time to become informed about the pros and cons of the many places and methods available for storing data. Consult with your advisers to learn how various laws may or may not protect your information and then make an informed decision that is within your comfort zone.