The article “These Tax Changes Could Open Up More Options For Real Estate Investors, Homeowners And Renters Of All Ages” was originally published in Financial Post on March 2, 2021.
Tax incentives may be more effective than disincentives to benefit the housing market
There was no federal budget in 2020 due to the pandemic, so the upcoming budget will be the first in two years. As home prices continue to rise, there may be tax incentives that could benefit renters, investors and seniors without further contributing to higher prices.
The Teranet-National Bank National Composite House Price Index rose by 9.6 per cent in January over the previous year. Meanwhile, the federal unemployment rate was 9.4 per cent, compared to just 5.6 per cent in January 2020, with an increase of more than 762,000 unemployed Canadians.
I am not a tax policy expert, but as a financial planner, I observe tax implications that influence people’s real estate and financial decisions.
Real estate investors can claim a variety of tax deductions when they own a rental property. They can deduct their rental expenses against rental income including mortgage or line-of-credit interest. They can also claim depreciation — capital cost allowance (CCA) — as a tax deduction as well.
For a $500,000 rental property with a $400,000 mortgage at 2 per cent, an investor may be able to claim almost $8,000 of annual interest costs. Depreciation could provide up to another $20,000 in tax deductions. A high-income taxpayer may save 50 per cent tax or $14,000 by claiming these deductions, let alone deductions for property tax, insurance and condo fees.
By comparison, a renter renting the same property may be eligible for a tax credit on the rent paid. In the country’s most populous province, the Ontario energy and property tax credit would provide up to $1,095 of tax benefits for a non-senior and $1,247 for a senior. However, the credit is only available to low- to moderate-income taxpayers. There are plenty of moderate- and even high-income renters, especially younger people.
As real estate prices rise, the mortgage interest and depreciation deductions rise with them, whereas the modest tax credits available for renters typically are adjusted annually based on inflation.
One of the deterrents for a real estate investor to sell a property is the capital gains tax payable on the appreciation. One half of a capital gain is subject to tax, as well as a recapture and full income inclusion of all previously claimed depreciation. The tax hit can be significant enough to keep an investor from selling to a potential homeowner who may want to live there.
There could be ways to incentivize a property owner to sell but ideally to the right buyer. One option could be a capital gains exemption or deferral if the property was sold to a tenant who lived in and rented the property for at least two years immediately prior to the sale (ideally an arm’s-length buyer who is not related). This could make a tenant’s offer to purchase a property or a landlord’s offer to sell a property to a tenant more appealing than involving a third party on the open market.
Real estate agents might not be in favour of this idea but maybe they could still help the buyer and seller on a fee-for-service basis to evaluate comparable properties and whether a tenant-landlord private sale made sense for the parties.
A limited capital gains exemption, a reduced capital gains inclusion rate, or the ability to defer the capital gain over up to five years, as examples, could help encourage tenant-landlord transactions.
I work with real estate investors and aspiring real estate investors whose capital could be put to good use by using tax incentives. There are federal and provincial tax deductions and credits to invest in flow-through shares issued by junior mining and energy companies. There are also tax credits to invest in shares of prescribed labour-sponsored venture capital corporations (LSVCCs). Tax deductions and credits could be used to attract investors to fund investment in affordable housing development investment funds. This might also allow smaller investments by those who might otherwise over-extend themselves to buy a rental property directly. If the funds were RRSP and TFSA-eligible, more investors could participate, and more people would contribute to their RRSPs and TFSAs instead of buying rental properties that are not otherwise eligible to be held in a registered account.
In the U.S., real estate investors can benefit from a like-kind exchange. A rental property can be sold and if a comparable property is purchased, the capital gain, or a portion thereof, may be deferrable until the sale of the replacement property. This would not necessarily increase the housing stock available for buyers but could at least increase the volume of transactions that is sometimes an issue in markets where there is not a lot of inventory or turnover.
In Australia, seniors who are 65 or older can downsize a primary (main) residence they have owned for at least 10 years and make a one-time downsizer contribution to their superannuation. A super is an investment account that has low tax rates during working years and tax-free status in retirement.
A similar incentive in Canada could encourage the sale of larger homes owned by seniors to potential buyers raising families by allowing a one-time downsizer contribution to a TFSA. A Canadian primary residence grows tax free as it is, so the ability to access more TFSA room may not necessarily allow more tax-free earnings for a taxpayer. But it could divert real estate assets to investment assets for retirees and free up housing stock for young people.
In the U.S., real estate investors can benefit from a like-kind exchange. A rental property can be sold and if a comparable property is purchased, the capital gain, or a portion thereof, may be deferrable until the sale of the replacement property. This would not necessarily increase the housing stock available for buyers but could at least increase the volume of transactions that is sometimes an issue in markets where there is not a lot of inventory or turnover.
In Australia, seniors who are 65 or older can downsize a primary (main) residence they have owned for at least 10 years and make a one-time downsizer contribution to their superannuation. A super is an investment account that has low tax rates during working years and tax-free status in retirement.
A similar incentive in Canada could encourage the sale of larger homes owned by seniors to potential buyers raising families by allowing a one-time downsizer contribution to a TFSA. A Canadian primary residence grows tax free as it is, so the ability to access more TFSA room may not necessarily allow more tax-free earnings for a taxpayer. But it could divert real estate assets to investment assets for retirees and free up housing stock for young people.
The Australian government has a limit of $300,000 for a downsizer contribution. Other restrictions may be needed to help ensure the intended outcome of helping increase the availability of homes and helping seniors, especially low- to moderate-income seniors, fund their retirements.
Recent tax measures such as foreign buyer taxes, empty homes taxes and the enforcement of business income tax rates instead of capital gains tax rates on real estate flippers may help bring balance to the housing market. However, as a father, I have consciously opted for positive reinforcement techniques rather than negative reinforcement with my kids. In much the same way, tax incentives may be more effective than disincentives for renters, investors and seniors, and for the benefit of the housing market — at least from this financial planner’s perspective.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
