Close capital gains exemption on home sales
Measure would be evasion-proof and simple, writes Rhys Kesselman.
The housing affordability issues of Toronto and Vancouver have prompted a national rethink of appropriate policy. Part of the dynamic in these cities has been speculation and tax evasion, and this should prompt a reconsideration of Canada’s long-standing capital gains tax exemption on owner-occupied homes.
The absence of a tax on these gains biases savers in their choices, exposing them to concentrated financial risks and depriving Canadian business of productive investment funds, while also fuelling house-price inflation. It also facilitates tax evasion by others who fraudulently claim the exemption or simply slip under the tax authorities’ radar.
Implementing a capitalgains tax on all home sales would be relatively simple, evasion-proof, equitable and economically efficient. Moreover, such an initiative would restore the notion that home ownership is mainly for the benefits of occupancy, not for speculation and investment purposes.
And it could be forwardlooking, exempting the gains accrued prior to the introduction of legislation.
Let me provide a rough sketch of how such a tax could work. Since the largest housing price gains have been in a few parts of the country — notably the major urban areas of British Columbia and Ontario — I describe how the tax could be implemented at a provincial level. Both of those provinces apply property transfer taxes, which would be the instrument for operating the new capital gains tax on homes.
A tax of this kind would improve the equity of the tax system. Once individuals exhaust their access to savings in tax-preferred forms, such as workplace pensions, RRSPs and TFSAs, any incremental savings are taxable. It is unclear why an individual with the same wealth in their home as someone whose savings are invested in financial markets or businesses should not bear similar taxes.
Many people have made hundreds of thousands, others millions, in tax-free gains on homes in recent years based purely on good luck — or devious manoeuvres. But others making far less through their hard labour are fully taxable on their earnings.
Moreover, the current tax exemption for sellers claiming their home as principal residence facilitates the tax avoidance of serial flippers. These individuals live in the home for the short period they undertake repairs or renovations, and then sell with all gains tax-free including the part reflecting their labours. A heavy tax on short-term gains would also discourage “flipping” activity by non-resident speculators.
Finance Canada projects that the absence of capital gains tax on principal residences will deprive the federal treasury of more than $5 billion in 2016 — likely an underestimate in view of buoyant sales in Toronto and Vancouver. Another $3 billion or more will go missing from provincial treasuries. Other countries tax gains on home sales, including the United States, albeit with an exempt threshold for tax.
The housing gains tax could be applied to all home sales by the relevant provincial authority for property transfer tax. The taxable gain would be calculated based on the sale price minus the original purchase price. Homes purchased prior to the new legislation would have their cost at that time based on the most recent appraised value; this would prevent the tax applying ex post to previous increases in values.
The tax would be deducted from net proceeds to the seller via the conveyancing agent, thus foreclosing the scope for evasion. Sellers who had incurred expenses for major upgrades to the property could claim those with the tax authority. Eligible documented expenses would increase the home’s cost basis. An allowance for general inflation over the holding period would also focus the tax on real gains.
To target the new tax most heavily on speculative holdings, the rate of tax could start quite high and decline with the owner’s holding period. For example, all sales within two years of original purchase could be taxed at 50 per cent of the real gain. The tax rate could decline uniformly over the holding period to 10 per cent after 12 years; that is, the rate would decline by one-third of a per cent per month.
An example illustrates the computation of the tax for a property. Assume that the home has been held for 15 years, purchased for $400,000 and sold for $1 million, with no outlays for improvements. If the tax has been in effect for the full 15 years, then the cost basis is $540,000 ($400,000 scaled up by 35 per cent inflation for the period), yielding a real gain of $460,000. At a 10 per cent rate the tax liability would be $46,000.
As the revenues from the new tax grow over time, they could be dedicated to reducing the property transfer tax on new purchases.
Housing affordability would be better served by relieving homebuyers at the outset and recouping revenues when they sell — and only to the extent that they reap real gains.
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