Why tinkering with the capital gains exemption is the nuclear option for housing market intervention – Financial Post

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Canada’s housing market has finally gotten so crazy that it is prompting talk about something almost sacred to homeowners: the tax-free profits they realize when they sell their main residence.

To be clear: the federal government has not said it’s about to start tinkering with the principal residence exemption from capital gains tax. However, Canada’s housing market has gotten so hot that it is at least a topic of conversation again, showing just how intense the demand for residential real estate has gotten.

That flurry of buying and selling has been driven by factors such as rock-bottom interest rates and a COVID-19-related desire for more space, which are also prompting some buyers to move more quickly for fear of missing out on a chance to own a home. Soaring home prices are increasing speculation that policymakers will step in at some point to try to calm things down, as they have in the past.

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“You’re seeing a reinvigorated debate on some of these sort of demand-side options,” said Jason Mercer, chief market analyst at the Toronto Regional Real Estate Board.

The preferred route TRREB and others in the real-estate industry would like policymakers to pursue is tackling the other side of the equation, by trying to boost limited housing supply that has also contributed to rising prices. That will take time, though, and the recent surge in home prices could translate into increased pressure for governments or regulators to intervene.

Royal Bank of Canada economist Robert Hogue wrote this week that policymakers should do something about “overheating” housing markets, because they present a risk to the economy, suck capital away from more productive purposes and can worsen inequality. One thing Hogue suggested was that governments should re-examine the support they provide for home ownership.

“Policymakers should put everything on the table, including sacred cows like the principal residence exemption from capital gains tax,” Hogue wrote. “These considerations will be complex, controversial and no doubt fraught with unintended side-effects. Yet this support was largely designed during times when interest rates were much higher, and in some cases to counter the effect of high rates.”

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A recent International Monetary Fund staff report on Canada didn’t mention the principal residence exemption by name, but it did reiterate the importance of policies that focus on “removing distortions” from housing markets.

“Even well-intended measures — like direct subsidies and tax deductions — can have perverse effects on housing affordability by favoring those that can already afford to buy a house at the long-term disadvantage of those that cannot, thus worsening existing inequalities,” the IMF report said.

In the United States, a couple can have capital gains of up to US$500,000 from the sale of their home excluded from their taxable income. Yet for Canadian policymakers, even just thinking about thinking about touching the capital gains tax exemption could leave them with few allies in the real estate industry.

“It will be an atom bomb on the retirement savings of Canada’s vast middle class,” said Tim Hudak, chief executive of the Ontario Real Estate Association. “Secondly, you think it’s hard to get a home now, imagine if they bring in a new tax on home equity. People will simply stay in their homes longer, maybe to the last parts of their lives, and that means that starter homes and move-up homes won’t come on the market.”

Even well-intended measures can have perverse effects on housing affordability

The exemption is one of the modern engines of Canadian homeownership and retirement planning, which may keep policymakers steering clear of messing with it in any fashion.

“Every single person says that at the end of the day, if I don’t stay in my own home, I can realize the entire fair market value on a tax-free basis, and then use that money to help fund or supplement my retirement,” said Jamie Golombek, a Financial Post writer and managing director, tax and estate planning with CIBC Private Wealth Management in Toronto.

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A lot of people are also counting on that nest egg to continue to grow.

Consumer expectations about increasing house prices strengthened recently to the highest level ever seen in the history of a survey conducted for Mortgage Professionals Canada, an industry association representing brokerages, lenders and others.

“Even on the heels of a 15 per cent year-over-year growth, more people than ever have told us that they anticipate prices will go up,” said Paul Taylor, president and chief executive of Mortgage Professionals Canada. “And that is a bit of a speculative warning sign, if you like.”

Taylor also said that measures aimed at curbing housing demand are “really blunt instruments,” for which he and MPC are not advocating.

If measures such as capital gains tax on principal residences is being considered, there needs to be a “trade off” with that, he said, along the lines of, perhaps, a capital gains tax exemption for other types of investments.

“Because in and of itself, you’re not going to encourage people to put their money somewhere else,” Taylor said. “People still are going to want to buy a house.”

• Email: gzochodne@nationalpost.com | Twitter: GeoffZochodne