Should Canada Tax Your House Gains?

Mike and Sabrina unpack the political third rail at the heart of Canadian housing.

What if Canada’s most protected tax break is making the housing crisis worse?

In this episode, Sabrina Maddeaux and Mike Moffatt explore the capital gains exemption on primary residences, why it exists, why politicians are terrified to touch it, and whether it unfairly advantages homeowners over younger Canadians and renters.

They break down the politics, economics, and unintended consequences of taxing home sales, while comparing Canada’s system to other countries and asking whether fixing housing affordability has become politically impossible.

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Below is an AI-generated transcript of the Missing Middle podcast, lightly edited.

Sabrina Maddeaux: In Canada, if you buy a stock or bond it goes up in value, then you sell it, you have to pay capital gains tax on the profits unless it’s a tax-sheltered vehicle like a TFSA. However, the same isn’t true of a home you use as a primary residence, which is exempt from capital gains taxes. This has led to concerns that the exemption has contributed to the housing crisis.

The Canadian Tax Federation notes that the exemption creates an incentive for families to overinvest in housing. And the exemption isn’t cheap either. It costs the federal government over $8 billion in lost tax revenue each year.

So, Mike, why does it exist in the first place?

Mike Moffatt: You’re not the first person to ask that question. And in fact, there have been proposals to change these rules over the years, but even the mere suggestion of changes tends to cause an uproar.

If we go all the way back to 2018, some Liberal caucus members from Ontario floated the idea of having capital gains taxes apply to homes that were owned for fewer than five years, as a way to deter housing speculation. This wasn’t even all homes - it it was just a small subset - but the Conservatives naturally pounced on it. And Justin Trudeau, the Prime Minister of the day, had to make it very clear that he or his government would never even consider such a move.

I know that any tax is bound to be unpopular. But why do you think a capital gains tax on housing is such a third rail, even one that’s designed to be an anti-speculation measure that would only hit a handful of people?

Sabrina Maddeaux: There’s always the fear that once you implement any tax, it just keeps expanding - which is a lot of the public’s experience in Canada.

But the idea that you put money into a home in Canada and then you’re entitled to its appreciation and it will be a retirement vehicle or something you can take out loans against in the hard financial times, is so psychologically baked in to the Canadian idea of home ownership and financial planning that it’s incredibly difficult, if not impossible, to convince homeowners to ever consider forgoing that. And a huge swath of the public - certainly the older population who votes and donates more and interacts more with politicians - are those homeowners who stand to benefit the most from the capital gains exemption?

At the same time, even if you come down with more taxes on potential speculators or investors, so much of the Canadian public are investors, or have secondary residences, because of the fact that we let housing skyrocket for years. The psychology was that it would always go up. And that psychology went from it’ll always go up to I’m entitled to it always going up and making all the money associated with that.

Mike Moffatt: That makes a lot of sense. People are entitled to their entitlements, as one politician famously said about 25 years ago.

It does make sense when you look at who is more likely to vote. Homeowners are more likely to vote than renters. Older people are more likely to vote than younger people. If you pick the wrong group to pick a fight with, it would seem to be older homeowners who have generated a whole lot of capital gains in their houses.

Sabrina Maddeaux: And that’s been the demographic that’s primarily freaked out when changes like this have been proposed over the years. But I’m curious: why were primary residences exempt from capital gains in the first place?

Mike Moffatt: It’s time for Professor Mike to give a little bit of a history lesson here.

The modern capital gains tax system comes out of a 1966 royal commission. And there’s this famous report - at least famous to econ nerds like me - called the Carter Report. The Carter Report advocated this exemption.

Now, their concern was just that it would be hard to enforce a capital gains tax on housing because you have to sort of monitor a bunch of things that the federal government wasn’t used to monitoring. You’d have to sort of figure out how to deal with inflation. The Carter report basically said it’s too much of a headache. Don’t bother.

But back when the federal government—the first Trudeau government—was designing the modern capital gains system, which went into effect at the beginning of January 1972, they’d actually considered making primary residences subject to tax. They’d have a small exemption that would allow you to get an additional thousand dollars a year in tax-free gains on your home, which these days sounds so unbelievably quaint. But in the end, they decided it was more trouble than it was worth. So they just made this a blanket exemption for primary residences. They’ve tweaked it a couple of times since then, but it’s basically unchanged since 1972.

Sabrina Maddeaux: That’s a really interesting history, and that very much tracks - that they decided it was more trouble than it’s worth.

As we know, there’s still a lot of housing data that we don’t track in Canada. And the CRA is often a mess. So I can only imagine the extra complications that would come with having to take into account reporting, home sales and values across Canada. But I’m wondering if other countries have exemptions similar to Canada's, or if we’re some unique outlier.

Mike Moffatt: It turns out a lot of countries have made similar recognition (*** check wording in audio) as Canada. This is just too much trouble to track.

Countries in general aren’t great at imposing any kind of wealth tax, which essentially this would be.

There was this report from the Korea Local Tax Research Institute, and they found that two-thirds of developed countries have no capital gains on primary residences. They looked at 40 different countries, and two-thirds of them had systems very similar to Canada’s. And of the remaining third, even those had a bunch of really broad exemptions. Ones similar to what those Ontario Liberal MPs proposed, that the capital gains only apply if you own a home for a few years. Or a lot of them have a rollover position, i.e. if you sell your home, but then you go and buy another one of equal or greater value, you don’t have to pay capital gains tax on that. It rolls over.

Of those 40 countries, there are really only four outliers: Japan, South Korea, Sweden and the United States, where having to pay capital gains taxes on primary residences is pretty common, at least for high-value properties. But even when you look at those, you have countries like the United States where some people do have to pay capital gains on their homes, but they get to deduct mortgage interest on their taxes. It’s like, “We’re going to tax you on one end, but we’ll give you this deduction over here.”

Sabrina Maddeaux: So we’ve covered how this impacts homeowners and sellers themselves. But what impact does the exemption have more broadly on housing and the nation’s finances?

Mike Moffatt: The big one is that $8 billion in lost revenue each year that the government could certainly use for other things, or to cut the taxes of young middle-class people, something that you advocate quite a bit. They could tax me more and you less. And I’m sure you’d be all for that. But if we go beyond just what this means for the federal government, the capital gains system does create some lock-in for older residents. And I can refer to a Globe piece that I wrote a few weeks ago about what can happen for an older person.

Let’s say you’ve got this house that is appreciated to 2 to 3 million and you’re 65 or 70. One of the things people suggest doing is, say, “I’m going to downsize at home, go into something smaller, and then put the remaining million or two into stocks and bonds and things like that.” If you do that, any of the capital gains that you get on the stocks and bonds over time- the dividends, the interest- you’re going to have to pay capital gains tax on. It does discourage older people from downsizing their homes. It does have all of these distortions, but there’s not a lot of evidence that it’s a major driver of our housing crisis.

And you just look at the countries that people point to as having affordable housing systems, like France and other countries. They all have Canadian-style exemptions. On the other hand, the United States, which we point to as the poster child for housing dysfunction, has one of the more stringent rules when it comes to capital gains taxation for housing. If you do this kind of cross-country comparison, it’s hard to say that these countries that have capital gains taxes have been able to avoid a housing crisis and that we should follow suit.

Sabrina Maddeaux: That lock-in factor is interesting. I’m curious. I would think that would come behind other factors preventing seniors from downsizing, like the lack of appropriate downsizing options in their communities, affordable downsizing options, and also the psychological toll and the difficulty that comes with moving.

Mike Moffatt: I agree. The psychological side of it, that’s never going to go away no matter what policy.

I would say that there is a bit of a chicken-and-egg thing here: part of the reason why we don’t have those downsizing options is that it’s not tax-efficient. I agree; it’s not the only thing that prevents older people from downsizing.

Some countries have tried to deal with this. Australia has a rule for older people that if you downsize, you can take some of those profits and put them into a TFSA-type vehicle. Then, with your future stocks and bonds, you can accumulate capital gains tax-free.

There are some countries that have tried to deal with this distortion. I don’t think we can point to it and say, “That’s the reason that seniors don’t downsize.” There are a lot of complex factors.

Sabrina Maddeaux: That’s an interesting solution coming from Australia, too, especially as people start to live longer. I mean, in years past, you might have downsized and then not expected to be around for another two decades. But now people are looking for ways to ensure their financial future and security for much longer.

But beyond the politics of it, would there be any downside to treating primary residences like any other asset for capital gains?

Mike Moffatt: One big problem is it would give investors a leg up, because right now, if it’s a secondary residence, you do have to pay capital gains tax on it. This system that we have now, with the exemption for primary residences, makes it easier for families to compete with investors. But if you levelled the playing field that way, by treating single families as investors, it actually advantages investors. Because investors, if you buy a single-family residence, you’re able to deduct mortgage interest against your rental income. But if you own the home as a primary residence, you can’t. That’s actually one of the reasons why the US has those rules to make mortgage interest tax-deductible. Because if you don’t do that, you create a system where investors are advantaged over families. And I think most people don’t want that. If Canada did change those capital gains rules, we would probably have to change a bunch of other rules too, or else we would be advantaged investors over single families.

Sabrina Maddeaux: I do think we have to be wary of that with any tax changes.

Both you and I have been big proponents of the HST removal for new builds in Ontario that came through recently. But what we’ve seen is that a lot of investors are now planning to buy up large amounts of units, and they’re going to get massive tax breaks because of this. The question is, how much is this actually going to benefit families who are buying homes, and will it bring new supply online that isn’t just existing supply that’s empty? I don’t know if you have any perspective on how this is rolling out.

Mike Moffatt: The HST side, I think it’s too early to tell. I’m a little bit less worried about investors buying condos. I view it as one corporation buying a bunch of homes from another corporation. And if they’re going to rent out those homes, I would prefer that to them being vacant.

I think it is still an open question around how much the HST changes are going to help the already built homes get into other people’s hands versus how much is going to create new supply. I think it will create new supply, but it’s an experiment. We’ll have to revisit this in a year when we have a little bit more data.

Sabrina Maddeaux: Follow-up episode.

Mike Moffatt: Absolutely. We love those.

Let’s leave the HST aside for a second, but let’s go back to the personal residence exemption on capital gains tax. Would you support changes there, or do you think any changes would be worse than the status quo?

Sabrina Maddeaux: In theory, I’d support it, but it’s so politically untenable and would take so much time and be implemented and then maybe rolled back that it’s just not worth it. I think there are other ways that we can get there quicker.

I’ve talked a lot about the fact that if we’re going to have massive tax advantages that largely benefit older Canadians and homeowners, then we need to look at tax vehicles that benefit younger Canadians and renters. So maybe it’s expanding capital gains exemptions to be a universal capital gains exemption, up to a certain amount, for any type of investment. Or maybe it’s allowing renters to write off a portion of their rent on their taxes. There are multiple options here. I do think there have to be changes to bring some fairness back into the tax system.

What are your thoughts?

Mike Moffatt: That’s essentially where I am as well.

When people suggest putting capital gains on primary residences, they are trying to solve a very real problem. There is a lot of inequality that is going on here, but I don’t think it’s the right vehicle. It’s administratively complex. It’s a political third rail. I think there are other things you can do. You went to the carrot side. I’ll go to the stick side.

It’s never made sense to me that a home valued at $300,000 pays the same property tax rate as one that’s $3 million. We don’t do that with income taxes. I would love to see the property tax system made more progressive. That if you have a less expensive home, you should pay a lower property tax rate than somebody who owns a $3 - $10 million home. Everybody’s going to be paying tax, but the folks with the less expensive home, maybe their tax rate is one-quarter of 1% of the home’s value. And then you can go into tax brackets. And then once you get above $5 million, it’s a 2% tax on top of that. I think you can make the existing system more progressive without having to introduce a measure that would be hard to enforce and very politically unpopular.

Sabrina Maddeaux: You see, that’s another one I agree with in theory, but our housing system is so broken that you couldn’t do that right now without a ton of add-on consequences and pushback. And the reason for that is that home values have become so inflated that you have people who bought in much earlier who don’t have super high incomes, but their home might now be valued at $1 to $2 million or even more, and they wouldn’t be able to afford the property tax increases.

I think that’s actually one of the reasons why, in Ontario, they haven’t reevaluated homes for property taxes since 2016. And they should be doing that. But people would riot if suddenly their home was valued at $1 million - although they would like to sell their home for $1 million or $2 million - but then they would have to pay the associated property taxes as they exist today, let alone higher rates.

Mike Moffatt: All of that makes sense.

First of all, we would have to have accurate property values, and at least here in Ontario, that’s not the case. You also have a lot of seniors who bought their homes in the 1970s or 1980s for next to nothing. Now, they have multimillion-dollar homes on paper, but they’ve never earned the incomes appropriate for those homes. They would be burdened by that.

And you also run into the same political challenges as the people who would have to pay higher property taxes are the same people who fought against having to put capital gains taxes on primary residences.

It’s one of those things an econ nerd like me, on paper, goes: “This might be an elegant solution, but it runs into all the political barriers that capital gains tax on primary residences runs into.”

Sabrina Maddeaux: And that’s the headline here: our housing affordability has become so out of whack and so screwed up that even common-sense, elegant solutions might not be tenable right now. We need to get things back in order.

Thank you, everyone, for watching and listening and to our producer, Meredith Martin, and our editor, Sean Foreman.

Mike Moffatt: And if you have any thoughts or questions about how common sense is no longer tenable, please send us an email to [email protected].

Sabrina Maddeaux: And we’ll see you next time.

Additional Reading/Listening that Helped Inform the Episode:

Canada should look to Australia on eliminating barriers to downsizing for seniors

The Conservatives' misleading claims about a 'secret' Liberal housing tax

Differentiated Capital Gains Tax by Number of Houses Only in South Korea... OECD Countries Exempt Primary Residence Regardless of Number of Houses

Capital Gains Taxation in Canada: History and Potential Reforms

Funded by the Neptis Foundation

Brought to you by the Missing Middle Initiative