Between the mid-1990s, when my wife and I bought an affordable semi in a gentrifying working-class part of Toronto, and today’s delusional housing market, I estimate the home’s resale value has grown by about $1 million. If we decided to sell, we’d qualify for the capital gains tax exemption for a principal residence because the house is where we live. That means we’d pay no income tax on its increase in value.
By contrast, if we’d chosen to keep renting for all those years and invest the difference in the stock market, not only would our total return likely be lower, but we’d also have to pay taxes on our investment income—at 50% our marginal rate for realized capital gains. (Even if we had invested inside the shelter of an RRSP, we’d have benefitted from annual tax deductions when we made our contributions, but we’d be taxed in full on both the original contributions and all the investment earnings when we draw those funds in retirement.) In other words, homeowner me gets to ensure that $1 million in equity accumulation remains beyond the reach of the taxman, whereas renter/investor me has no such privilege.
This so-called “home ownership bias” in tax codes has been a well-recognized phenomenon for decades. “There have been numerous studies that show that if you include tax benefits, 95% of funding at all levels of government—federal, provincial, municipal—go to homeowners, not renters,” says Carolyn Whitzman, a retired professor of urban planning and expert adviser to the Housing Assessment Resource Tools project at the University of British Columbia. Moreover, these benefits tend to be encased in politically bomb-proof armour. “Definitely a third-rail issue,” Whitzman says, recalling a raucous debate about reducing Australia’s version of the capital gains exemption that played out while she taught at the University of Melbourne.
But as house and condo prices in Canada rise inexorably, at a pace well beyond increases in average household income, it seems reasonable to predict that an ever-larger proportion of the country’s population is looking ahead to a lifetime of renting. So, one can ask, why do homeowners get to put their fingers on the scale, even when there’s plenty of evidence these benefits are helping to widen the wealth gap between those who own property and those who don’t?
In Canada, the principal residence exemption (PRE) dates back to a 1972 tax reform law that represented the culmination of a decade of debate about how to make the national revenue system more equitable for lower-income households. Alongside the PRE, the law provided measures such as deductions for childcare expenses, as well as new taxes on capital gains associated with other investment classes. Such was the temper of the times.
Even today, Ottawa’s stated reason for providing the PRE is that it creates a “social benefit.” “This measure,” a summary of the 1971 bill stated, “recognizes that principal homes are generally purchased to provide basic shelter and not as an investment, and increases flexibility in the housing market by facilitating the movement of families from one principal residence to another in response to their changing circumstances.” Given the speculative madness of the real estate market circa 2022, the language is almost shockingly anachronistic.
Homes today are absolutely an asset class. They provide financial security for retirees, income streams for Airbnb hosts or, indirectly, tax-free investment vehicles in the guise of real estate investment trust units. Contractors, realtors and speculators buy, renovate and flip houses to drive up their resale value, while developers market condos to investors.
And while owners of investment properties don’t qualify for the PRE—they must pay tax on any capital gains when they sell or otherwise dispose of the property—that hasn’t kept them from trying to use the exemption to avoid a tax hit. Indeed, the matter of determining whether a tax filer can claim the PRE has become a cottage industry for accountants, even as the Canada Revenue Agency and federal tax courts move to clamp down on people trying to pull a fast one.
In this spring’s federal budget the government went further, saying it will be introducing new rules to ensure that profits from flipping properties will be taxed “fully and fairly.” The Liberals also announced they’ll be wading into the sloppy national conversation about the financialization of housing with “a review of housing as an asset class, in order to better understand the role of large corporate players in the market and the impact on Canadian renters and homeowners.” However, there’s no mention of rethinking the PRE.
That’s not only because it would be political suicide—one online poll done before last fall’s federal election found more than two-thirds of respondents were opposed to taxing principal-residence capital gains—but also because there’s a view among some economists that doing away with the PRE wouldn’t accomplish much anyway. “The argument for taxing capital gains on the sale of owner-occupied principal residences is twofold,” wrote the C.D. Howe Institute’s Jeremy Kronick and Alexandre Laurin in a 2021 policy brief. “First, the argument goes, the tax will decrease demand, putting a stopper on illogical price appreciations. Second, governments are starved for tax revenue, and taxing these gains would help fill that gap. In practice, however, neither of these is likely to play out as expected.”
In fact, since the Liberals took office in 2015, the estimated foregone revenue due to the PRE through this year tops $55 billion, according to Department of Finance statistics. By contrast, the budget for the 10-year National Housing Strategy, their much-hyped plan to improve affordability, is $72 billion.
And what about the argument of fairness? 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 with higher interest rates, they will never actually go down—why is the tax system not neutral when it comes to one’s form of housing?
“I’m pretty favourable to the idea that the tax system should be neutral to the tenure of housing,” says Kevin Milligan, a professor of economics at UBC’s Vancouver School of Economics. “My instinct as an economist is that we ought to have people making their own choices about how they live, how they work and how they save, rather than having the tax code push them one way or the other.”
To that end, Canadian policy makers could begin thinking about some form of rebalancing—such as allowing renters to put more money into tax-free savings accounts as a way of closing the equity-accumulation gap between those who own homes and those who don’t. “Maybe there’s an argument for that,” Milligan says. “That could make some sense for providing an equal opportunity for tax benefits to renters.” Of course, such a solution wouldn’t help governments fill public coffers in the face of diminishing tax revenues.
As the ranks of renters increase steadily, and the wealth chasm between owners and tenants grows ever wider, the politics of the principal residence exemption might someday soon get flipped, too.
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