February 27, 2008

 

Title: Real estate industry proposal left out of recent budget

Sub-title: Housing sector stakeholders disappointed that promised capital gains measures were brushed aside.

 

While yesterday’s federal budget was greeted with a big yawn by many, one group was disappointed. For years, apartment building owners, real estate investors and agents have been asking the federal government to provide tax relief for those who sell existing rental properties and then invest the proceeds in new ones. However the recommendations were quietly ignored.

 

Real estate industry stakeholders say such as move would spur urban growth, provide economic spin-offs and help both the middle-class and small investors. Yet while reactions to the industry’s proposals from individual Members of Parliament and Department of Finance officials were said to have been positive, momentum now appears stalled.

 

According to the Canadian Real Estate Association, “capital gains tax adjustment remains the last unfulfilled Conservative Party campaign promise from the last election.” And by not including the requested changes in their recent budget, the government missed a golden opportunity to spur urban regeneration and to increase the tax system’s fairness in its treatment of different classes of investors. 

 

A real estate rollover

Real estate industry stakeholders feel that they have been discriminated against. In a nutshell, they are asking that capital gains and recaptured depreciation taxes be deferred when they dispose of a rental property, but then reinvest the proceeds in another within a short period of time. The move would extend a benefit that is already available to businesses to individual investors too. Proceeds for sales of rental properties that were not reinvested in new properties would continue to be subject to taxes.

 

The move would spur substantial investment and lead to urban renewal in many areas says one expert. “There is strong evidence that when investors buy new property, they often make improvements and the dollar amounts can be very significant,” says Avrom Charach, an accountant with Kay Four Properties and chairman of the Canadian Federation of Apartment Associations. “It is also clear that many investors continue to hang on to older, deteriorating properties or warehouses that could be upgraded or converted to rental units. Owners know that if they sell those properties they will be stuck paying significant capital gains and other taxes.”

 

According to research commissioned by the industry stakeholders and conducted by two university professors, Thomas Wilson from the University of Toronto and James McKellar, from York Univesrsity, the new measures would cost about $452 million during their first year in operation. However that number does not take into account the economic spin-offs that the project is expected to generate.

 

The benefits of capital gains tax deferrals

That said, according to the CREA research, the benefits of providing property owners with relief appear compelling. Ironically, the biggest winners would appear be middle class investors. According to CREA’s research, about two-thirds of the 94,455 Canadians that reported real property gains in 2005, have incomes of $50,000 per year or less. Those gains worked out to $3.8 billion, or 57 percent of all gains reported.

 

Real estate investors have been hit by a series of blows by various Canadian governments over the years. For example all Canadians benefit from life time capital gains exemptions, however in the 1980s investments in real estate were specifically excluded. The reasons for this remain unclear. According to the CREA research, real estate investments are every bit as productive as other vehicles because they produce “a future flow of accommodations services just as other investments produce a future flow of goods and services.”

 

Real estate investors are also discriminated against by the current Good and Services Tax regime because landlords (unlike business owners) are not allowed to recover taxes paid on the purchase, repair or improvement of residential properties.

 

The effect on renters

One group whose interests are not specifically targeted by the proposed tax measures but who would almost certainly benefit is renters. According to the Canada Mortgage Housing Association, the average vacancy rate in Canada’s 34 major centers hovered at 2.6 percent between October 2006 and October 2007, substantially lower than the 3.0 percent level that experts regard as the equilibrium rate for the industry.

 

“There is demand out there,” says James Brennan external relations director at the Canadian Real Estate Association. “And while we did not specifically study the effect that the proposed changes would have on renters, there are indications that they would cause that demand to ease.”

 

Better luck next time

According to a spokesperson at Finance Minister Jim Flaherty’s office, there were no specific reasons as to why the real estate industry stakeholders’ proposals were not included in the current budget document: “the standard answer that we give in these types of situations is that we get lots of proposals and we cannot include all of them,” which translates roughly into “better luck next time.”

 

Peter Diekmeyer (peter@peterdiemeyer.com) is Bankrate.ca’s Quebec correspondent.

 

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