Canadian real estate and capital gains taxes are once again in the spotlight. This week the NDP’s Jagmeet Singh promised to crack down on “big money” house flippers. This strategy largely involves hitting them with a 75 percent capital gains rate. Owners feel this will unfairly target them. Supporters think this will encourage more productive investments, outside of real estate. They’re both wrong… at least the way the NDP has proposed implementation.
WTF Are Capital Gains Anyway?
First, let’s talk capital gains. Capital gains are the difference between the price you sell an asset for, and your cost basis. The cost basis is typically the price paid, minus eligible costs incurred. If your capital gains are positive, you’ve made a profit that can be taxed at the inclusion rate. When the gain is negative, you incurred a loss and can often use this to offset gains at the inclusion rate. Totally aware inclusion rate means nothing to most of you right now, so let’s quickly discuss.
The inclusion rate is the percent of capital gains (or loss) included for tax purposes. Most investments in Canada are taxed at a 50 percent inclusion rate. That means 50 percent of the income is taxed as though it were regular income. For example, if you made $100 on an investment made with an inclusion rate of 50 percent, you would pay taxes on $50. This effectively cuts your tax rate in half for the item. This is important for Canadians to understand since all investments aren’t treated equally.
Canadians Don’t Pay Capital Gains On Their Primary Residence
In Canada, unlike the US, the capital gains on a principal residence have an inclusion rate of 0 percent. According to the Canada Revenue Agency (CRA), this is generally true if:
- Your home was your principal residence for all years you owned it, or for all years except one year
- You report the sale of the property and designate it as your principal residence on Schedule 3 and complete Form T2091(IND)
- You or a member of your family did not designate any other property as a principal residence while you owned your home.
Not Your Primary Residence? You Have To Pay Taxes On The Gains
Not your primary residence? You generally have to pay taxes on the gains for that property. A non-primary residence typically falls into two major categories — personal and business. If you own a few properties over your life that aren’t your primary residence, it’s considered an investment. These folks are usually subject to the 50 percent inclusion rate.
Businesses, incorporated or not, that trade property have to pay a full rate. This includes flippers, and other folks generating regular “business income” from the sale. Companies pay their business rate, and people pay the income tax rate. At least in theory, but some people in practice get away with not paying it. Those agents boasting about making buttloads flipping and paying lower taxes? They might have got away without claiming the capital gains rate, but most likely paid the incorrect amount of taxes. It would likely be considered business income by the CRA, meaning it should have been taxed at a 100 percent inclusion.
Home flippers will sometimes “move” into a project, and claim it as their primary residence. This used to be popular, but the CRA has explicitly said this can void a primary residence exemption. You may have gotten away with it a few times, but that doesn’t mean it’s how the taxes work. The more times it’s done, the more you increase your chances of being caught. When that happens, they can circle back and seek back taxes.
No, this isn’t just a rant. It’s important for understanding how the NDP plan actually works, and who will be targeted.
The NDP Plan Targets Owners of Multiple Homes and Flippers
The NDP plan is somewhat vague right now, but they aren’t targeting primary residences. Singh said they’ll be hitting home flippers with a 75 percent capital gains rate, up from 50 percent. The 50 percent part is really important because this only applies to certain people. Owners of multiple homes and occasional flippers would be the demographic targeted.
They aren’t targeting primary residence owners. They pay a 0 percent inclusion rate, not 50 percent. Increasing the rate of those that pay 50 percent, definitely has no impact on those who just regularly live in their home. Professional flippers also aren’t targeted by this, since they shouldn’t be paying capital gains. They currently should be paying business income.
No, This Plan Doesn’t Encourage More Productive Investment
The theory behind a capital gains tax on homes is to encourage productive investment. It ideally discourages non-productive housing investment and puts it into more productive uses. This benefits an economy in three major ways:
- Housing becomes less expensive, since fewer dollars are chasing the same asset for returns;
- Fewer dollars spent on shelter means more money for other areas of the economy. Spending 10 percent more on rents or mortgage payments mean 10 percent less in the rest of the economy. This becomes a drag on the economy, which lowers the return on homes anyway;
- Investors are encouraged to seek more productive investments. These tend to produce higher velocity capital growth, leading to long-term prosperity.
The NDP plan doesn’t do any of this, since it’s an extension of a general move to increase all capital gain inclusions. Previously the NPD promises to hike the inclusion rate to 75 percent for all investments. This would have hit the same class of housing investors he’s “targeting.” Even before he explicitly said he would be targeting them.
Targeting all investments fails to distinguish which are productive and which aren’t. The goal is to encourage speculators to invest in other areas. If the incentive, or disincentive, is the same for all types, you’ll just keep doing what you do. In other words, it would have little to no impact on housing. It just straight up taxes all investments at a higher rate.
Implementing a capital gains tax on a primary residence is a totally different story. When experts like BMO suggest considering a primary residence capital gains tax, it’s not about revenue. It’s also not about making sure people make less money either. It’s about discouraging households from over-allocating to housing. If households are encouraged to invest in housing, that’s where all of their money goes. If they are discouraged, they diversify their holdings.
Ironically, this NDP plan would negatively target Millennials more than it would change anything for speculators. Middle-class Millennials that aren’t homeowners only have the stock market to preserve wealth. By taxing them at a higher rate, and leaving a homeowner’s primary residence untouched, Millennials would be at a disadvantage. The investor class? No one is incentivized to do things differently. They just have to pay higher taxes.
Photo: NDP Canada.
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