Canada’s housing agency recommends converting more buildings to residential, but tax laws operate like it’s the 1940s.
by Ken Grafton, Marc Denhez. Originally published on Policy Options
April 25, 2023
In October, Canada’s housing agency recommended stepping up efforts to reduce the shortage of skilled residential construction labour to address the lack of housing affordability. It also zeroed in on the clear need to convert more existing buildings into residential units.
“It may be costly but converting existing structures into residential units can be a quick way to use the labour capabilities we have,” Canada Mortgage and Housing Corporation (CMHC) said in its Housing Market Insight report. “This is especially true for commercial structures that have become vacant because of people working remotely because of the pandemic.”
This common-sense recommendation, however, is not supported by federal policy. In fact, it contradicts longstanding tax legislation, which is strongly biased in favour of demolition over renovation (conversion) – in effect, statutory “planned obsolescence.”
The roots of tax legislation go back to the 1940s, in the post-war heyday of “planned obsolescence.” At the time, then-deputy minister of finance Clifford Clark overhauled the tax system and introduced lucrative tax advantages to developers with wrecking crews, and creating a demolition-driven market dynamic that continues to this day.
Added to the Income Tax Act were generous depreciation allowances (today, a rental apartment building is presumed to lose half its value, in constant dollars, in 10 years); avoidance of “tax recapture” (payback of the deductions claimed for this over-depreciation) upon demolition; and a “terminal loss” provision that allows the deduction of any remaining book value after demolition.
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Further, deductions for repairs that many landlords consider vital are disqualified on the basis that the work represents “too much of an improvement.” That was the case, for example, with asbestos in the 1990s, when some landlords sought to remove it. The explanation? The removal has an enduring benefit. (Today, CRA says this “may not represent (its) current position” – but it does not say what that position is). CRA may also disallow expenses that extend the “useful life of the property.”
In addition, there is GST/HST. In the 1990s, the federal government doubled its sales taxes on renovation. As a supposed “revenue-neutral” quid pro quo, it introduced a “substantial renovation” rebate – but only on condition that the building is gutted, destroying at least 90 per cent of non-structural elements.
Meanwhile, new units inserted into an existing residential building – “secondary suites” – are ineligible for the GST new housing rebate, the only kind of “new housing” to be excluded. This year, the government instead introduced a one-time grant of $7,500 for such suites, but only on condition that the suite be installed for a family member.
At the municipal level, tax structures typically favour vacant lots. In Ottawa, for example, owners of parking lots will pay substantially less property tax per dollar of evaluation than for apartment buildings, retail stores or factories. Capitalizing the tax savings on converting a building to a parking lot can be equivalent to a grant worth hundreds of thousands of dollars.
The American property tax system, too, favours vacant lots, which litter the country’s biggest cities. “A skewed property tax system is worsening the housing crisis,” according to the Wall Street Journal. “Cities all over the country are littered with empty or sparsely built sites. Some economists say they share a common factor: a tax system that combines low taxes on land, and high taxes on buildings.”
Josephine Faass, PhD and executive director of the Robert Schalkenbach Foundation, told the WSJ: “Traditional property taxes – perversely – disincentivize the sort of land use that we want to see in our cities. When you’re taxing improvements, you’re signaling to the market that you don’t want improvements.”
As a result of our tax structures, the commercial advantages of demolition discourage the very conversions recommended by CMHC to create more affordable housing.
In the midst of a housing crisis, millions of square footage of space in existing buildings – both residential and commercial, available without any new foundations to pour or infrastructure services to install – go unutilized because longstanding national policy encourages those structures to be leveled.
It traces back to the concept of planned obsolescence, which was born out of something called “creative waste,” an economic concept introduced in 1932 to drum up more consumer spending in the early years of the Great Depression. Disposing of things and buying new ones could be good for the economy, authors Roy Sheldon and Egmont Arens wrote in their book Consumer Engineering: A New Technique for Prosperity.
Clifford Clark embraced planned obsolescence, and it remains the foundational principle of federal tax policy governing Canada’s building industry today. It fuels our replacement culture, with thousands of serviceable structures being levelled every year instead of being converted into affordable housing units.
“Most buildings are demolished for reasons that have nothing to do with the physical state of the structural systems,” Forintek Canada, a wood products research institute, said in a 2004 paper. “Our overriding conclusion is that no meaningful relationship exists between structural material and average service life.”
As long as existing tax law provides significant financial rewards for demolition, it will not be possible to implement CMHC’s recommendation to focus on conversions. Developers simply can’t afford to ignore the windfall tax benefits of demolition.
To encourage building conversions, the following changes will be necessary:
Income Tax Act
- Eliminate over-depreciation on existing buildings (historically, real estate appreciates over time), and adjust it to reflect actual building life-expectancy.
- Eliminate the “terminal loss” provision for demolished buildings.
- Disqualify demolition costs as deductible expenditures.
- Recognize renovation costs associated with adding housing units in existing buildings as deductible expenditures.
Excise Act – Goods & Services Tax (GST)
- Qualify “secondary suites” under the New Home Rebate program.
- Eliminate demolition as the criterion for eligibility for the Substantial Renovation Rebate.
- Reduce GST on residential renovations.
Municipal property taxes
- Reverse tax structure to increase taxes on vacant lots and lower taxes on developed lots.
Until these legislative measures are adopted, the affordable housing crisis will remain.
Take, for example, Ontario’s “Bill 23: More Homes Built Faster Act,” which was enacted recently by the Doug Ford government. It ostensibly aims to create more affordable housing by stripping planning control from municipal governments, eliminating/reducing development charges, destroying Greenbelt lands and decimating the Ontario Heritage Act and Conservation Authorities Act. It is an example of poorly crafted legislation that fails to address the real impediment – tax policy – to creating more affordable urban housing.
The recent federal budget introduced a new “refundable Multigenerational Home Renovation Tax Credit, which will provide up to $7,500 in support for constructing a secondary suite for a senior or an adult with a disability.” But it also announced the government’s intention to “support the reallocation of funding from the National Housing Co-Investment Fund’s repair stream to its new construction stream” – a retrograde action intended to discourage renovation.
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CMHC recommends putting a push on to begin assessing existing buildings that could be suitable for people to live in and figure out how many could be converted instead of demolished and rebuilt. “If more companies start embracing remote working,” it says in its October report, “we could see more new housing supply come from existing structures, where people can upgrade or renovate them to create new homes.”
Only by creating a market dynamic biased toward renovation as opposed to demolition can government really address affordable housing in an effective and meaningful way, through better use of the existing building stock.
Canada has almost $6 trillion worth of buildings. Given today’s housing challenges, the CMHC recommendations must be adopted.
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This article first appeared on Policy Options and is republished here under a Creative Commons license.