A Case for Excluding Real Estate from the Purview of the Revised Capital Gains Policy to Promote Wealth Creation and Economic Development

May 31, 2024

By Allwyn Dsouza, Senior Analyst, Research and Insights, REIC/ICI

For the first time since 2001, the government is adjusting the capital gains inclusion rate. For individuals, the rate will shift from a flat 50% to a tiered system: 50% for gains under $250,000 and 66.67% for gains exceeding $250,000. For corporations and trusts, the inclusion rate is set at a constant 66.67%, regardless of the gain amount. This new rule will apply to all capital gains realized on or after June 25, 2024. The government anticipates that this adjustment will generate $19 billion over the next five years to support its $19 billion housing initiative. The change aims to promote tax fairness, with the government estimating that it will impact only 0.13% of Canadians (approximately 40,000 people), who have an average income of $1.4 million. [1]?

If the tax primarily affects the super-rich, why are so many ordinary people upset about the proposal? Although $250,000 might seem like a substantial capital gain that would exclude most individuals, this isn't entirely accurate. We analyzed the situation from a real estate perspective, considering that homeownership is one of the most significant investments for Canadians and a major source of capital gains.?

The home price data in Figure 1 for townhouses, detached homes, or apartments purchased in 2016 or earlier reveals that these properties often fall within the price range that would earn more than $250,000 in capital gains. If we consider the average sales data of around 40,000 homes per month as published by CREA [2] and an average holding period of 10-12 years, it results in approximately 2.4 million homes being bought between 2012 and 2016. These homes have capital gains exceeding $250,000 and are likely to come onto the resale market. This number is significantly higher than the 0.13% of Canadians expected to be affected by the new tax.?

Figure 1.0

Due to the significant rise in real estate prices in recent years, the increased inclusion rate for capital gains tax could heavily impact those with second homes, such as cottages or investment properties, as well as individuals who inherit properties.?

While capital gains on a principal residence are excluded, many people who inherit properties will face this additional tax burden. These individuals are often not wealthy, and many plan to use their inheritance to purchase their first homes. This scenario shows that people of moderate means could easily accumulate gains exceeding $250,000 and realize that gain in a single year. Thus, the policy might affect a larger portion of the population than the government anticipates.?

Another argument is that many landlords are wealthy investors with multiple properties. While this is partly true—according to a study by the Canadian Housing Statistics Program [3]—multiple-property owners held between 29% and 41% of the housing stock in Ontario, British Columbia, Nova Scotia, and New Brunswick in 2019 and 2020. Additionally, multiple-property owners comprised 22% of all owners in Nova Scotia, 20% in New Brunswick, 16% in Ontario, and 15% in British Columbia. However, the situation is more nuanced than it appears.?

The same study indicates that over 70% of these multiple-property owners have just one additional property. This makes sense, given Canadians' preference for real estate as an investment and a way to build generational wealth. Real estate is a tangible, income-producing asset that is easier to understand than equities, bonds, and other asset classes, making it particularly attractive to those in lower income brackets. This is also substantiated by the government’s data that shows that real estate constitutes a larger portion of net worth for lower-income individuals compared to those earning high income.??

Figure 2.0

For many, capital gains represent a once-in-a-lifetime event involving their lifetime savings. Thus, the capital gains tax raises the marginal tax rate for these investors significantly more than for those high-income individuals who rely on capital gains as a regular income source.

A study by the Canadian Housing Statistics Program in 2020 revealed that most of these investors have incomes below $100,000, which is significantly lower than the $1.4 million income level mentioned in the budget statistics.??

Table 1.0

Other studies, like the one by the Fraser Institute, indicate that in 2020 [4], 38.4% of capital gains in Canada were paid by individuals earning less than C$100,000, which contradicts the government's claim that the new tax measures target only the wealthy.??

We see the policy exacerbating the very problem it plans to solve.?

The tax could reduce the supply of resale houses due to the lock-in effect: Multiple studies have shown that capital gains taxes create a lock-in effect, where investors are incentivized to hold onto their assets instead of selling them. Capital gains are taxed when the asset is sold, so many investors may delay selling to avoid the tax. Consequently, the government might be overestimating the potential revenue from the capital gains tax increase, as individual investors will likely adjust the timing of their sales. Since investors hold 30-40% of the housing inventory, this could significantly impact supply, which the government aims to address. Additionally, investors are crucial for providing rental housing, which is essential for those who cannot afford to buy a home due to factors like income, credit score, financial indebtedness, and high prices.?

To address the supply issue, the government needs to attract more investment, not deter it. The problem extends beyond direct demand. Although the government has offered lower inclusion rates and lifetime capital gains incentives for startups, these still apply to private and venture capital investors. Many startups, especially in high-tech sectors, rely on risk capital funding. Higher capital gains taxes could drive this funding elsewhere, along with the new startups, jobs, and talent.?

Over the same period, $19 billion over five years is less than 1% of the federal budget. Is it economically wise to disrupt the market for such a marginal amount? These collections could be even lower if investors delay sales. Such deferrals would not only reduce the proposed tax revenue but also hinder investments in new ventures, as capital would remain tied up in older investments longer than anticipated.?

Impact on new housing starts: Developers typically need to sell around 70% of their inventory to secure construction financing. The new capital gains tax could deter investors from purchasing, particularly given the current high-interest rate environment. Without sufficient investor participation, new homes might not get built, further constraining supply. It is unrealistic for developers to depend solely on first-time home buyers, especially for projects in emerging areas where social infrastructure is still developing and attracting end users will take time.??

On one hand, the government has set an ambitious goal to build over 3 million homes by 2031. On the other, they have created a supply problem by deterring investors and developers in the private sector. Without their participation, the government will need to significantly increase its efforts in building more public housing. Hence, it would be prudent to exclude real estate from the purview of the capital gains tax change as it affects ordinary Canadians much more than the wealthy.??

At a time when Canada urgently needs to boost investment incentives, the government's 2024 budget has introduced a harmful tax increase. While delivering the budget, Finance Minister Chrystia Freeland stated, “Canada, a growing country, needs to make investments in our country and in Canadians right now.” This sentiment is likely shared by individuals and businesses nationwide. Therefore, the government should be encouraging investments, but raising capital gains taxes will have the opposite effect. Reduced business investment and slower economic growth will negatively impact all Canadians, resulting in lower incomes and decreased living standards.?

[1]?Government of Canada: Tax Fairness for Every Generation

[2] CREA: Home Buyers Remain Cautious Amid Increasing Spring Listings

[3] Multiple-property holders own up to 41% of housing in some provinces: StatCan

[4] Fraser Institute: Correcting common misunderstandings about capital gains taxes

Allwyn Dsouza is REIC’s Senior Analyst, Market Research and Insights. He can be reached at [email protected] . Media enquiries can be directed to [email protected] .