Using Tax Policy to Address Real Estate Concerns

October 4, 2016

Vancouver, as well as many other large metropolitan centers, has been facing a well-documented housing crisis. Recently, Canada announced new rules concerning foreign ownership of real estate as one of many attempts to fix this problem using the tax code.

The rules include a move to tighten the restrictions surrounding the Canadian principal residence tax exemption. As it currently stands, taxpayers do not have to pay a capital gains tax – a tax on the increased value of the residence – when selling homes as long as the home was designated as a principal residence for every year the taxpayer owned it. In order to be designated a principal residence, one or more of the homeowners, a former spouse, or their children must have lived in that home at some point during the year.

As homeowners did not previously have to report the sale of properties claimed as principal residences, this system has been widely abused by foreign buyers looking to avoid paying the capital gains tax upon the sale of their property investments. The Canadian federal government stated that these changes will ensure that families only designate one property a year as a principal residence, and that this exemption is used only by Canadian residents.

Worldwide Real Estate Investment Boom

Canada is not the only country feeling the effects of foreign real estate investment. In the first five months of 2016, Chinese foreign commercial real estate investment totaled US$17 billion, making it the second largest foreign investor in commercial real estate after the United States, and Chinese investment makes up 60 percent of Asian outbound real estate investment. Chinese purchases of foreign residential real estate have also grown.

Though affected by many factors, these foreign purchases have helped housing prices in many major metropolitan areas grow at rates unmatched by income. Looking at the median multiple – the median house price divided by median household income – Vancouver and four cities in California are among the top ten least affordable major metropolitan markets in North America. Many of the countries represented on this list have attempted to use the tax code to discourage, or constrain, foreign investment.

10 Least Affordable Major Metropolitan Markets

Rank: Least Affordable

Affordability Rank (out of 87)

Metropolitan Market

Median Multiple

1

87

Hong Kong

19

2

86

Sydney, NSW

12.2

3

85

Vancouver, BC

10.8

4

82

Melbourne, VIC

9.7

4

82

Auckland

9.7

4

82

San Jose, CA

9.7

7

81

San Francisco, CA

9.4

8

80

London (GLA)

8.5

9

78

Los Angeles, CA

8.1

9

78

San Diego, CA

8.1

Source: “12th Annual Demographia International Housing Affordability Survey: 2016 Rating Middle-Income Housing Affordability,” http://www.demographia.com/dhi.pdf

Past Canadian Attempts

The principal residence tax exemption is not Canada’s first attempt to cool the housing market. Vancouver in particular is trying to use the tax code to address the low vacancy rate, as well as excess foreign purchases of real estate.

According to Vancouver Mayor Gregor Robertson, more than 10,000 homes stand empty, and another 10,000 are “underutilized,” having been purchased as investments. In order to address this problem, Vancouver plans to tax investors who have vacant properties, hoping to raise the near 0 percent vacancy rate to between 3 and 5 percent. This tax will be enacted at the beginning of the new tax year, and thus people will likely be paying the tax in 2018 at the earliest. The exact rate has yet to be decided, but Vancouver’s general manager of community services Kathleen Llewellyn-Thomas has stated that this tax might be as high as 2 percent of the property’s assessed value.

The province of British Columbia also passed a 15 percent property-transfer tax applying to foreign nationals and overseas corporations, which went into effect on Aug. 2. Following the new property transfer tax on homes, sales activity in Greater Vancouver in August was down 35 percent from its December 2015 value.

Singapore

Singapore introduced the Additional Buyer’s Stamp Duty (ABSD), a tax levied on the purchase of residential properties, in December 2011 and revised it in January 2013 in order to control skyrocketing property prices. The ABSD is levied on top of the Buyer’s Stamp Duty (BSD), which imposes marginal rates of 1 to 3 percent on the value of primary properties. The ABSD levies different duties depending on the type of investor and number of properties, but it levies a top rate of 15 percent on international investors’ first property, a much higher rate than that for citizens or permanent residents.

Additional Buyer's Stamp Duty (ABSD) Rates, Singapore

Type of Property

ABSD Rates (from January 2013)

Type of Investor

First residential property

N/A

Citizen of Singapore

Second residential property

7%

Third residential property

10%

First residential property

5%

Permanent Resident of Singapore

Second residential property

10%

First residential property

15%

Foreigners and Entities

Source: https://www.iras.gov.sg/IRASHome/Other-Taxes/Stamp-Duty-for-Property/Working-out-your-Stamp-Duty/Buying-or-Acquiring-Property/What-is-the-Duty-that-I-Need-to-Pay-as-a-Buyer-or-Transferee-of-Residential-Property/Additional-Buyer-s-Stamp-Duty–ABSD-/

There is also the Seller's Stamp Duty (SSD) for Residential Property, which is payable on all residential properties and lands bought after February 2010. The actual rate, which can be anywhere between 0 and 16 percent, depends on the date of purchase, holding date, and market value of the property. It is levied on foreigners and citizens alike. These measures seem to be working, as the prices of private residential properties have been decreasing since 2013.

Australia

Australia tackles foreign investment through strict foreign buyer limitations and tax policy. Two provinces in Australia – New South Wales and Queensland – introduced a stamp duty, a tax levied on the purchase of property, of 4 and 3 percent for foreign buyers respectively. Earlier in the year, Victoria increased its preexisting stamp duty surcharges for foreigners from 3 percent to 7. New South Wales also introduced a 0.75 percent land tax surcharge on real estate investors that will go into effect next year. The limitations include the need to be approved by the Foreign Investment Review Board and the inability to buy older properties, among others.

Australia’s measures to curtail foreign investment seem to be working. Chinese real estate agents who have historically focused on Australian properties have switched to European and U.S. properties, citing the tough lending requirements and the higher taxes as reasons.

United Kingdom

All of the United Kingdom’s methods have thus far been aimed at making sure foreign investors are subject to the same level of taxation as UK residents, while discouraging the purchase of second homes.

The United Kingdom introduced a capital gains tax on foreign owners of UK property that came into effect in April 2015. This tax ensures that foreign owners and UK residents paid the same tax of between 18 and 28 percent on the sale of residential property that is not a primary residence. In addition, a recent stamp duty land tax increase of 3 percent for additional residential properties went into effect in April, and the HM Treasury was quick to clarify that it applies to foreign nationals and UK residents alike.

New Zealand

Compared to other countries, New Zealand has relatively few property taxes – there is no capital gains tax or stamp duty. As a result, the New Zealand property market is booming, with the sale of homes worth more than $1 million increasing 63 percent from last year. New Zealand is still concerned with a potential housing boom, and has introduced new property-tax legislation, which introduces a sales levy on homes resold within two years of purchase, and requires nonresident buyers to register with the country’s tax department.

United States

The United States is already a popular source of foreign real estate investment, and U.S. properties are likely to become more popular as Canada continues its tax reform. China has recently surpassed Canada as the top foreign investor in U.S. real estate, with the growth rate of new investment averaging 20 percent between 2010 and 2015. There are already eleven U.S. cities where the house price to income ratio is viewed as “severely unaffordable,” and an influx of foreign investment into these cities is likely to exacerbate this problem.

The rise of housing prices coupled with a stagnating median wage is a problem of great concern to policymakers, but they should be careful about trying to address this issue with tax policy. As seen in Canada or Singapore, tax policy can help reduce speculation by foreign investors. But as Vancouver has experienced, it can also lead to falling home prices, which affects domestic and international investors alike.


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