Few doubt Canada’s real estate market is overheated, and while several tax regimes have failed to curtail runaway housing prices in recent years, the government still has a ‘nuclear option’ at its disposal.

The federal deficit billowed before the COVID-19 pandemic induced the government to roll out several income support programs, thereby adding to the country’s debt -- and with nary a hope of paying it down soon, taxes are more than likely about to rise.

A recent report explored several scenarios that could play out in Canada’s real estate market over the next five years, one of which was that the capital gains tax exemption on primary residences could be repealed. Such a bold move would also surely bring activity in the real estate market to a near standstill, which in theory could rectify rampant affordability woes.

However, the ramifications would be unlike anything previous real estate-related tax regimes have had, posits Jamie Golombek, Managing Director, Tax and Estate Planning at CIBC Private Wealth, which wrote the report with RE/MAX and the Conference Board of Canada. For starters, rescission of the capital gains tax exemption could even upend millions of Canadians’ retirement plans.

“The primary homes of Canadians represent the greatest store of value for most homeowners and removing a significant portion of that value by eliminating the exemption could cool the market in profound ways,” Golombek said in the report. “While it theoretically will improve government coffers, it would be a blunt blow to the net-worth of Canadian households, which in turn could dramatically swing the housing market from hot to cold.”

Little Choice But to Tax

In spite of the deleterious effects such a move could have on Canadians’ wealth, Brian Poncelet, an independent certified financial planner, expects it will be announced in one of the next few federal budgets, the next of which is April 7.

Capital gains is normally taxed at 50%, but Poncelet believes a primary residence levy would be around half of that. Echoing the report, he believes the government will have little choice but to tax Canadians to the hilt due to extravagant spending.

“The housing market should have been dealt with years ago. The horse ran out of the barn five days ago and they just decided to close the door,” he said. “I could see them saying that, ‘Instead of 50%, we’ll drop it down to 25%.’ With the sheer amount of debt the government has, in my opinion, it will have to.”

A strident capital gains tax on primary residences could plausibly open up another can of worms, though. Bradley Watson, host of Toronto’s #1 Real Estate Podcast and a broker with Sutton Group – Summit Realty Inc., says such a tax would despoil end-user homeownership of its intrinsic value and create unsustainable rental demand.

If capital gains is taxed anywhere near as much on a primary residence as on an investment property, it could spawn an investor class who see real estate in purely asset-leveraging terms. But considering Canada’s major urban areas already have too little rental supply, growing demand will invariably result in higher rental prices, Watson surmises, which would spread to secondary and tertiary markets.

“Investors will go into lower-priced assets in smaller markets knowing the benefit of a primary residence is no longer there,” Watson said. “If a primary residence is the same as an investment property, you will see people steer towards the rental market as a means of shelter for themselves and invest in areas that offer better returns on their investments. Why buy a $1.3M detached in Toronto and pay a mortgage when you’re better off owning a home as an investment vehicle that will provide you an income source that is more valuable than owning the home you live in?”

Granted, the housing market in its current state is as untenable as Watson’s theory of what could befall the rental market, which are already pushed to their brims in many nationwide markets, but other tax regimes like the foreign buyer and speculation taxes haven’t achieved their desired outcomes. However, it is hard to imagine that home-buyers and –owners alike would not shudder at such a scenario. Shelter as an asset class rather than a family decision, Watson says, would be destabilizing. 

“Every real estate purchase would then become a business decision,” he said. “Where that leads is business, and profitability, decisions would spread to outskirt communities. How that will trickle down to the rental market is you would have an inflow of not only immigrants but locals opting to rent because they would no longer see the value in ownership, and competition among renters would be so high it would push rental prices up.”

Political Suicide

However, Ben Myers, President of Bullpen Research and Consulting, notes that Canada’s homeownership rate hovers around 70% and rescinding the capital gains tax exemption on primary residences would be political suicide.

“I have a hard time believing that it would fly in a country of 70% owners, a high percentage of whom are also voters,” Myers said. “For a government to make that kind of change, it would certainly upset a lot of people. A lot of people are planning on selling their homes when they retire and move into rentals or smaller places, or even become snow birds, so they’re counting on keeping all their equity gains when they do that.”

Should the federal government proceed with such bold policy, Myers believes fewer Canadians would sell their homes, which would exacerbate the resale market’s supply problem—demand has outpaced available inventory even more than usual in the last year, driving sale prices up at an accelerated stride. But if a capital gains tax on primary residences were digestible -- that is, even lower than Poncelet’s 25% estimate -- it could conceivably fly.

“If it’s small enough, it wouldn’t have a big impact, but if it were too large it would have a big impact,” Myers said. “It all depends on what the rate is. If they throw on some huge tax, it will impact people’s decisions to move because they won’t want to pay that tax. In Toronto, they added on a second land transfer tax and that certainly didn’t seem to slow anyone down.”

In light of recent news that Jagmeet Singh’s NDPs will buttress the federal Liberals on most of its policymaking decisions, essentially obliging the latter with de facto majority government privileges, Poncelet can see the door opening to a primary residence capital gains tax being introduced, especially because, he suspects, it wouldn’t alienate their bases. Moreover, even investor-targeted taxes could be in the cards, he added.

“If you have four properties, they could say ‘You have to pay a little extra.’ Politically, if you have four properties you probably won’t vote NDP or Liberal, so they’re thinking, ‘If I annoy you, and I know there’s a good chance you’re not going to vote for me, do I really care?’”

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