House Prices and the Canadian Government

On Monday October 3, 2016, the federal government came out with some changes to the Income Tax Act, as well as some mortgage rule changes. These rules are supposed to respond to the run-up in housing prices.

The mortgage changes may be helpful, but as my regular readers know, I’m often a bit cynical about changes to the Act. In my view, they’re mostly done for their optical appeal; they rarely change much. These changes qualify in spades. The government, in my humble opinion, is hoping people will mistake words for actions.

There’s only one thing I am steamed about, and that’s the extension of the time for reassessment.

Finally, I don’t think any governmental action so far really addresses the problem, mostly because there’s no common definition of the problem. This is the important (and interesting) part of today’s blog, so keep reading. You can skip the boring, but necessary comments on the tax changes, to get to the good stuff.

Principal Residence designation

“One-plus” rule

When you a person sells a home, some of the gain is exempt. The exemption is calculated as a formula:

(1 + number of years designated) / (number of years owned)

Only one home can be designated a principal residence for a particular year by a family. This is to prevent one spouse from designating the main home, and the other from designating the cottage.

The purpose of the “one plus” portion of the formula is to account for the fact that people will often sell their old home and buy a new one in the same year. Without the “one plus” rule, on the second house sale, there would be a year that could not be designated, and there would be some tax.

The new rule requires that in order to use the 1+ rule, the taxpayer must be resident in Canada during the acquisition year.

Not a biggie.

Trusts

Trusts are generally eligible to claim the exemption. Starting 2017, only certain trusts will be eligible to claim it. But the narrowing of these rules is very limited.

Reporting

When filing a tax return, form T2091 is used to report the designation of a principal residence, and it is how one claims the exemption. This is not a new form. The penalty for failure to file is $25/day up to $2,500. There is no change to the law in this regard.

What, you’ve sold a home and never heard of this? Administratively, CRA allows non-filing if you were claiming a complete exemption. Since this is the case for just about everyone, nobody filed the form.

The government did not indicate whether CRA will start enforcing the penalty.

Reassessment time

Normally, CRA can reassess a taxpayer up to 3 years after the date the notice of assessment is issued. With the new rule, if a taxpayer fails to report a disposition of real estate (using T2091), CRA will be allowed to assess at any time. Yes, this means forever.

This is a major change – it’s the same thing that applies when there is fraud. I’m opposed to putting people who forget a form, especially in a situation where they think the gain is non-taxable, in the same position as fraudsters.

The other thing is that I’m not sure this information gathering will be at all helpful. There are about 525,000 home sales per year in Canada. Reporting each of these will simply give CRA a haystack out of which to extract needles. It’s not going to be much help in catching the cheaters.

Now to the fun stuff.

If you really wanted to solve the problem

First, you’d have to define what the problem is:

• Prices rising in the Toronto and Vancouver markets, so that homes are out of the reach of millennials?
• A housing “bubble” that is at risk of popping?
• Empty houses in Vancouver, threatening the pleasantness of some neighborhoods?
• Canada providing a safe haven for “dirty” money?
• Foreigners not paying tax on gains on Canadian real estate?

It’s really important to know what the problem is, because the solutions to each are quite different. So let me deal with each in order.

Affordability

I think affordability is the political crisis – in other words, it’s a crisis to politicians. It’s what gets them to do things. Keeping homes within reach of millennials requires holding down prices. That, effectively, penalizes the current owners, who have been betting on rising prices.

Even aside from the poor implementation (no grandfathering of signed deals), the BC 15% tax is a bad idea. It hits many people who aren’t real targets, and misses others who are. For instance, what if a foreigner is about to move to Canada, and buys a home for her family to live in when they get here? What if a person is coming to Canada on a work permit? Why are they penalized? On the flip side, Canadian permanent residents and citizens who live abroad are unaffected by this tax.

We know the effect of price controls (been there, done that, probably don’t want to see the movie again). Of course, one could raise interest rates, but that would have all sorts of implications.

Financial instability

The “bubble” is a risk, and it would be easy to deal with it – have the government stop insuring mortgages. Leave it to the market to figure this out, and let the market take the risk. Right now, banks will lend to all comers who qualify, safe in the knowledge that they have no meaningful skin in the game. If the market provided the insurance, it would become internationalized. Canada’s banks would insure the mortgage in world markets. Then if the bubble pops, it would be but a blip. Canada’s too small to matter. And the people who get hurt would only have themselves to blame. Personally, I don’t think it’s a bubble (more below).

Neighborhood beautification

There are already municipal rules requiring people to maintain their homes and yards. Vacant or not, these rules still apply. All that’s needed is enforcement. There aren’t many neighborhoods that are seriously affected by this. I think it’s a trumped-up charge for effect.

Money Laundering

Corruption in China is endemic. Everybody is paying off everyone else. The system is set up so that everyone is vulnerable to a charge of impropriety by someone else. It’s not Canada’s job to figure out where the money came from, unless it’s something that would be a crime in Canada. All we need to do is ensure people obey Canadian laws.

Canadian tax evasion and avoidance

I live in this system. I don’t think there’s a lot of tax being lost to evasion. Of course there is some – you’re never going to catch everything. But most of the so-called abuse is actually legal. Canadian laws allow individuals to come here, plant their families, and go back “home” to continue to make money – all without paying Canadian tax. So be it. Canada gains by having immigrants (the kids) who, by and large, grow up to be productive members of society. Remember, the people who can afford to do this are among the wealthy in their home countries. They have an interest in seeing their kids succeed. And like past generations, they see Canada as a safe place for their children. Everybody wins.

What's really happening to prices

The big rise in prices has happened mostly in Vancouver and Toronto; the rest of the country has been largely exempt from this phenomenon. It’s my view that these are secular economic events. These two cities are in the process of moving into the top tier, or at least the second tier of world cities (New York, London, Paris, San Francisco, etc.). The commonality is that locals can’t really afford to buy homes there, because the price is determined by money outside the local market. Locals end up renting.

There’s not much one can do about this, other than make the city unattractive to rich people around the world. The costs of doing that are pretty awful. So I think we’re stuck with the result. And it’s not such a bad result.