Ottawa may move to hike the capital gains tax. A bad idea.

Goodman Report

Concerns are mounting that the delayed 2020 federal budget will include an increase in the capital gains tax on income-producing real estate. We contend that lowering the tax should be considered for owners of multi-family housing.

Originally scheduled to be released in March, the 2020 federal budget has been delayed indefinitely due to the COVID-19 pandemic. The pandemic has also caused the federal debt to increase exponentially, which will have a direct bearing on federal budget considerations.

As of March 31, 2021, the projected federal debt will be $1.43 trillion, according to the federal government’s Economic and Fiscal Snapshot released on July 8, 2020. This debt level is unprecedented in Canada and should be considered astounding for a country with a population of less than 38 million.

The debt crater has deepened fears that the minority Liberal government will decide an increase in the capital gains tax would be a politically popular method to increase revenue. The current capital gains inclusion rate is 50%, making it one of the most efficient corporate taxes available.

Support from NDP, Green parties

The minority Liberals can likely count on the support of both the NDP and the Greens for such a move. In the last federal election, the NDP campaigned on increasing the capital gains inclusion rate to 75%. This would raise an extra $8 billion in tax revenue in the first year alone, according to estimates from the federal parliamentary budget office. The Green party has recommended that all capital gains be subject to taxation.

Canada first introduced a capital gains tax in 1972. The tax rate has remained unchanged since 2000 and is now the 14th highest among the 34 countries that were members of the Organization for Economic Co-operation and Development in 2013, according to the Fraser Institute, in its report Economic cost of capital gains tax in Canada.

Fears of an increase in the capital gains tax has been among the top five predictions prior to the federal budget for decades, but this year the forecasts may be on the money, according to noted analysts, including Wilmot George, vice president of tax, retirement and estate planning with CI Investments Inc., Jason Heath, managing director and certified financial planner with Objective Financial Partners Inc., and Ian Russell, president and CEO of the Investment Industry Association of Canada.

In July 2020, a rumour ripped through Canada’s news media that the federal government was considering the first capital gains tax on the sale of private homes. The Canada Mortgage and Housing Corp. was quick to dismiss such fears, but suspicion remains. Raising the capital gains tax on commercial property, such as multi-family residential, appears less far-fetched at this stage.

“If push comes to shove in a minority government, where there is quid pro quo, where the NDP are prepared to support a high-tax, high-spend budget, the Liberals may be willing to sacrifice on capital gains [and raise the rate],” Russell said.

There will be no warning

One thing is certain: if the federal government decides to hike the capital gains tax, there will be no forewarning, which means it would most certainly be sprung in a federal budget. This is because owners would take immediate steps to reduce their exposure if they knew for certain the higher tax was coming.

What is also certain is that any increase in the capital gains tax would be a blow to owners of multi-family residential property, a sector that is already subject to much higher taxes and regulation than any other commercial real estate sector.

In British Columbia, for example, residential landlords are restricted to raising rents to a level just above the inflation rate, pegged at 1.4% for 2021, while office, industrial or retail landlords can raise rents to realistic market levels. Also, multi-family property is subject to the 20% provincial foreign-homebuyer tax, the provincial speculation tax and other measures as if it is residential, not a commercial investment.

Of course, for most of 2020, all B.C. landlords have been forbidden to increase rents due to the pandemic and have not been allowed to evict tenants for non-payment of rent. At the same time, costs for property taxes, hydro, water, insurance and maintenance continue to increase. Despite this, B.C. landlords have been quick to provide rent relief to their tenants during the pandemic. Rents in the city of Vancouver, for example, have been reduced an average of 8% this year compared with 2019, according to a July national rent survey by Rentals.ca and Bullpen Research and Consulting.

Capital gains hike would hit smaller owners

An increase in the capital gains tax would hammer B.C.’s multi-family landlords, the vast majority of whom are considered “mom-and-pop” investors, holding the small, older apartment buildings that constitute the bulk of the rental inventory. For these owners, the potential equity gain on their investment is the major impetus to ownership in the first place. A sudden hike in the tax could wipe out years, even decades, of price appreciation.

Raising the capital gains tax on multi-family property would also chill new construction of purpose-built rental units, which are just starting to recover after decades of slow growth.

Is an increase in the capital gains tax coming? No one outside of Canada’s Finance Ministry and the Prime Minister’s Office knows for sure. Our opinion is that multi-family landlords should be rewarded after years, even decades, of paying Canada’s highest real estate taxes while providing the essential service of rental housing. That reward should include a decrease in the capital gains tax specific to multi-family housing to further incentivize owners to invest their hard-earned capital in this asset class. Only time will tell.