Between the mid-1990s, when my wife and I bought an affordable half in a working-class part of Toronto, and today’s phantom housing market, I estimate the home’s resale value has grown by about $1 million. If we decide to sell, we will qualify for the capital gains tax credit for a main home because the home is where we live. This means that we will not pay any income tax on the increase in value.
By contrast, if we choose to continue to lease all those years and invest the difference in the stock market, not only will our total return likely be lower, but we will also have to pay taxes on our investment income – at 50% our marginal rate of capital gains realized. (Even if we had invested within an RRSP, we would have taken the annual tax deduction when we made our contributions, but we would be taxed in full on both the original contributions and all investment profits when withdrawn. The stock is still out of tax reach, while my lessee/investor has no such privilege.
The so-called “home ownership bias” in tax laws has been a known phenomenon for decades. Says Caroline Weitzman, retired professor of urban planning and expert advisor to the Housing Assessment Resource Toolkit project at the University of British Columbia. Moreover, these benefits tend to be politically covered by bomb shields. “Certainly the third rail case,” says Wittsman, recalling a vociferous debate about curtailing the Australian version of the capital gains exemption that occurred while she was teaching at Melbourne University.
But with home and apartment prices in Canada rising relentlessly, at a pace that outpaces increases in median household income, it seems reasonable to expect that a growing proportion of the country’s population is looking to rent for life. So, one might wonder, why do homeowners put their fingers on the scale, even when there is plenty of evidence that these benefits help widen the wealth gap between those who own real estate and those who don’t?
In Canada, the Principal Residence Exemption (PRE) dates back to the 1972 Tax Reform Act which is the culmination of a decade of debate over how to make the national revenue system more equitable for low-income families. Besides PRE, the law introduced measures such as deductions for child care expenses, as well as new taxes on capital gains associated with other investment classes. This was the mood of the era.
Even today, the stated reason in Ottawa to introduce PRE is that it creates a “social benefit”. The summary of the 1971 bill states that “this measure” recognizes that primary homes are generally purchased to provide basic shelter rather than as an investment, and increases flexibility in the housing market by facilitating the movement of families from one primary residence to another. in response to their changing circumstances.” Given the speculative frenzy in the real estate market around 2022, the language is shockingly almost outdated.
Homes today are definitely an asset class. They provide financial security for retirees, income streams for Airbnb hosts or, indirectly, tax-deductible investment vehicles in the guise of real estate investment trust units. Contractors, realtors, and speculators buy, renovate, and flip homes to increase their resale value, while developers market apartments to investors.
And while investment property owners do not qualify for PRE — they must pay tax on any capital gains when they sell or dispose of property — that hasn’t stopped them from trying to use the exemption to avoid a tax. In fact, the question of whether a tax holder can claim PRE has become a household industry for accountants, even as the Canada Revenue Agency and federal tax courts move to clamp down on people trying to pull one off fast.
In this spring’s federal budget, the government has gone further, saying it will introduce new rules to ensure that profits from flipping real estate are taxed “fully and fairly.” The Liberals also announced that they will delve into the uneasy national conversations about housing finance by “reviewing housing as an asset class, in order to better understand the role of large corporations in the market and to influence Canadian renters and homeowners.” However, there is no mention of rethinking PRE.
That’s not only because it would be political suicide — an online poll taken before the federal election last fall found that more than two-thirds of respondents were against taxing major residence capital gains — but also because there is a view among some economists that getting rid of will not work. PRE a lot anyway. “The argument for capital gains taxation on the sale of owner-occupied prime housing is a double one,” Jeremy Kronik and Alexander Loren of the CD Howe Institute wrote in a 2021 policy brief. First, the argument goes, the tax will lower demand, stopping irrational price hikes. Second, governments are deprived of tax revenue, and taxing these gains would help close this gap. However, in practice, it is unlikely that either of these things will do as expected.”
In fact, since the Liberals took power in 2015, estimated revenue lost due to PRE this year has exceeded $55 billion, according to Treasury Department statistics. By contrast, the 10-year National Housing Strategy, their much-touted plan to improve affordability, is budgeted at $72 billion.
What about the equity argument? If Canadian society is headed in the direction of European countries where large segments of the population live in long-term rentals – after all, while house prices may rise less quickly as interest rates rise, they won’t actually go down – why is the tax not a neutral system when Is it about the individual’s housing?
“I’m very supportive of the idea that the tax system should be housing-tenure-neutral,” says Kevin Milligan, professor of economics at the Vancouver School of Economics at the University of British Columbia. “My instinct as an economist is that we should have people making their own choices about how they live, how they work and how they save, rather than having the tax law pay them one way or another.”
To that end, Canadian policymakers could begin to consider some form of rebalancing — such as allowing renters to put more money into tax-free savings accounts as a way to bridge the stock accumulation gap between those who own homes and those who don’t. R. “Maybe there’s an argument for that,” Milligan says. “That might make sense to some extent to provide an equal opportunity for tax benefits to tenants.” Of course, such a solution would not help governments to fill the public treasury in the face of diminishing tax revenues.
With the number of tenants steadily increasing, and the wealth gap widening between landlords and tenants, the main residence exemption policies may one day be overturned as well.
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