There has been lots of noise about introducing capital gains tax on primary residences in Canada to slow down the rapid acceleration of house prices. Before I dive into the details and why this is a terrible idea, let’s discuss economics.

Economics 101

Product price is driven by supply and demand. In early 2021, the Toronto real estate market and the surrounding areas have experienced double digit price appreciation due to the strong imbalance between supply and demand. There have been many cases where houses and now condos were up for sale and the number of buyer offers were double digits. Yes, one property with 10, 12, 18 buyer offers. That’s the definition of a strong imbalance in the supply/demand equation.

For Toronto’s real estate market to be balanced, we need to be at 3-5 months of inventory. In February 2021, the Toronto detached MOI (months of inventory) was at 1.03, Toronto semi-detached MOI at 0.61 and central Toronto condos MOI at 0.95 (All figures are from TRREB February monthly market report).

There are 2 options to get to 3-5 months of inventory:

1. Supply of homes listed for sale needs to 3X - 4X current levels

2. Over 50% of the buyers would have to stop looking for a home

Capital Gains

As the real estate market continues to be strong in early Spring 2021, there has been more noise in the media about introducing capital gains tax on owner occupied homes in Canada.

Background

Currently when a real estate investor sells their investment property, 50% of the profit is added to their taxable income.

Here is a simplified example:
Investment property bought for $500k, Sold 10 years later for $825k with acquisition & disposition costs at $25k.

Profit: $825-$500k-$25k = $300k.
Taxable profit: 50% of $300k = $150k gets added to the real estate investor’s taxable income

Why is this a bad idea?

The real estate market is overheated due to lack of supply and strong demand. Policy makers need to focus on the supply side of the equation. The market is hot now, what will happen when the Federal government allows for 400k immigrants for 3 years starting in 2022.

More people…..more homes needed (more supply of homes!!)

Introducing capital gains tax on primary residence will discourage homeowners from selling their properties. Once a homeowner calculates their net proceeds taking into account a new capital gains tax, they might be discouraged from putting their home for sale. This will lead to less supply.

Less supply will backfire and put further upward pressure on home prices.

We need more supply.

Some have said that the US has capital gains tax on primary residences. They sure do, however the interest portion of the owner occupied home mortgage is a tax deduction, they do not have our immigration levels and they have tax exemptions: $250k of capital gains or $500k for a couple.

What about low interest rates? Yes they are historically low, however all homebuyers and real estate investors have to jump over the mortgage qualification rate which is at 4.79% at the time of this publication. That’s right, you can borrow at 2-2.5% but you have to qualify at 4.79%.

Policy makers are hesitant to address the supply issue since it’s a political hot potato, NIMByism is alive and well. People want more housing but in someone else’s neighbourhood.

My final thoughts, say no to capital gains on your primary residence……and tell your MP and MPP we need more homes.

Till next time….