Allan Lanthier: Yes, we should tax capital gains on principal residences
The principal-residence exemption is 50 years old and past its best-before date
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My wife says to batten down the hatches, because our friends and neighbours know where we live. So here I go, about to put my family’s safety at risk: As a matter of tax fairness, the federal government should propose limitations to the principal-residence exemption in its upcoming budget.
Of the 37 members of the Organisation for Economic Co-operation and Development (OECD) only a handful — Canada being one — fully exempt gains on a personal residence. So how did Canadian homeowners become part of this elite and privileged group?
It all started in 1966, when the Royal Commission on Taxation (the Carter Commission) released a massive 2,600-page report with sweeping proposals for Canadian tax reform. One was the introduction of capital gains taxation, but with a lifetime exemption of $25,000 for gains on personal residences (a little over $200,000 in today’s dollars).
The Carter report met fierce opposition from vested interests, and many of the measures finally enacted in late 1971 paled in comparison to the original proposals. A prime example is that the legislation provided a complete exemption for gains on a principal residence. A leading tax lawyer stated at the time that “the exemption serves as a reminder that taxation is after all a political process.”
A principal residence is the only asset totally exempt from Canadian tax. An entrepreneur with shares of a Canadian private corporation can claim a lifetime exemption for approximately $892,000 of capital gains. The corporation has likely helped grow the economy and employ Canadian workers: still, the exemption is capped. The principal residence exemption, on the other hand, has no limit at all. The primary reason for this largesse? Political expediency: more than 65 per cent of Canadian voters are homeowners.
Advocates of the exemption argue that tax-free gains are needed to fund retirement. That may be true for some homeowners: for many others the exemption will simply increase the massive generational wealth transfers that are already on the horizon. In any event, our tax code uses registered pension plans, RRSPs and TFSAs to support retirement planning. They are available, as they should be, to all Canadians, not just homeowners. And the exemption is costly: in its present form, the combined federal-provincial cost is about $11 billion a year.
The United States provides exemption for gains on personal residences as well, but to a limit of US$250,000 or US$500,000 for married couples. What would happen if Canada introduced a similar cap? For example, capital gains on a personal residence might continue to be fully exempt for dispositions until the end of next year. Assume that 25 per cent of such gains were taxable for dispositions that occur in 2023 and 50 per cent (the normal capital gains inclusion rate) in 2024 and subsequent years, but with a lifetime exemption of $500,000 (indexed) per individual or family unit.
Individuals who in future realize gains of up to the $500,000 indexed limit would suffer no tax. Those with accrued gains that exceed this limit might decide to sell before the new rules are fully in force: the proposal might therefore increase the supply of available housing units somewhat (and ease housing prices) in the near term. In the longer term, it seems unlikely that this proposal would have any significant impact on supply or demand or, therefore, on housing prices.
Critics say that if Canada were to adopt this type of lifetime limitation, mortgage interest and property taxes should be deductible, as they are in the United States. Let’s get the facts straight. In the U.S., taxpayers can either claim the standard deduction or “itemize” and claim expenses such as mortgage interest. Fewer than 25 per cent of U.S. homeowners do itemize, and so deductible mortgage interest is the exception, not the rule.
In addition to the U.S., at least 15 other OECD-member countries offer some relief for mortgage interest, though it’s hard to understand why. The few studies that exist suggest this type of tax assistance induces individuals to buy larger and more expensive homes but has no impact at all on the number of homeowners. In addition, some economists suggest that these types of subsidies may distort investment decisions and lead to over-investment in housing at the expense of business investment.
The principal-residence exemption is 50 years old and past its best-before date. It is time the government took a hard look at other alternatives.
Allan Lanthier is a retired partner of an international accounting firm and has been an advisor to both the Department of Finance and the Canada Revenue Agency.
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