Toronto real estate

Tax experts say they’re unsure how Ottawa might target real estate investment trusts (REITs) that invest in rental residential housing, or indeed how a change to their tax treatment would help alleviate the issue of housing affordability in Canada.

The federal Liberals promised to review, and possibly reform, the tax treatment of REITs as part of a broader strategy to make housing more affordable for ordinary Canadians and bring “fairness” to the housing market.

“Large corporate owners of residential properties such as [REITs] are amassing increasingly large portfolios of Canadian rental housing, making your rent more expensive,” the Liberals indicated in their 2021 campaign platform. “Homes should be for people to live in, not financial assets for investment funds to speculate on.”

In a March 22 “supply and confidence” agreement, the Liberals and the New Democratic Party promised to implement a Homebuyer’s Bill of Rights and “tackle the financialization of the housing market by the end of 2023.”

REITs allow investors to pool resources to invest in real estate, which can include portfolios of commercial, industrial, residential and other types of properties. REITs are not taxed on the income and gains generated in the trust, but instead flow these out to unitholders. If an investor holds a REIT in a tax-exempt vehicle such as an RRSP, tax on the distributions can be deferred until the investment is withdrawn.

When part of the distribution from a REIT is a return of capital, it is not immediately taxable to the investor — though such a distribution will lower the adjusted cost base of the investment and increase the eventual capital gain (or reduce the capital loss) on the sale of the investment.

Enzo Testa, partner with accounting firm RSM Canada in Toronto, said he’s uncertain how the government could target the tax treatment of REITs, but added that the investments have become increasingly popular in recent years.

REITs that invest in residential rental estate “look for properties that are undervalued, properties where they can spend some money to upgrade them, and then increase the rent,” Testa said.

As leases on residential properties are typically single-year, not multi-year, as with commercial or other types of real estate, investors consider the investment more “dynamic” and “inflation proof,” said Testa. “People need to live somewhere, especially when they can’t afford to buy.”

John Nicola, CEO and chairman of Nicola Wealth in Vancouver, said he’s also uncertain about what aspect of the tax treatment of rental housing REITs concerns the federal government. However, he said targeting such REITs — and/or other large owners of residential real estate such as life insurance companies and pension plans — might disincentivize investment and run counter to Ottawa’s broader goal of boosting housing affordability.

“It’s hard to see how reducing the supply of rental housing helps the overall housing market,” said Nicola in an email.

Rick Robertson, emeritus professor of managerial accounting and control with Ivey Business School at Western University in London, Ont., said he would be “surprised” to see the government alter the flow-through tax treatment of REITs, saying that structure allows retirees and other retail investors to generate steady income and participate in an investment class that would otherwise be inaccessible.

“Large pension plans can go buy the building itself — the rental property,” Robertson said. “Whereas you and I are just the little guy; we should at least have a vehicle as attractive [as the institutional investors have].”

Robertson said he believes the Liberals will ultimately decide to leave the tax treatment of REITs unaltered and focus instead on promises they made to “protect renters” in their 2021 campaign platform.

In their campaign document, the Liberals said they would stop “renovictions” by deterring “unfair rent increases that fall outside of a normal change in rent” and requiring “landlords to disclose, on their tax filing, the rent they receive pre- and post-renovation, and implement a proportional surtax if the increase in rent is excessive.”

The Liberals have promised to double the First-Time Home Buyers’ Tax Credit to $10,000 from $5,000 and to introduce the First Home Savings Account (FHSA), which would feature tax-free contributions and withdrawals with the goal of helping Canadians under 40 to save up to $40,000 toward a first home. They also promised an anti-flipping tax, requiring homes be held for at least 12 months in order to access the principal residence exemption.