NDP School Tax

Another (Un-?) Intended Consequence of the NDP’s “School Tax"

By on 11/08/2018

By now, many have heard about the NDP’s steep new asset tax on homes assessed above $3 million, which the government has pleasantly but misleadingly called the “School Tax Surcharge”. Many also now know that in fact this new tax has nothing to do with schools, is going into the general ledger, and is hitting hardest in a city that already subsidizes all the other school districts in the province. Vancouver is the only school district in BC where the school taxes collected cover—and in fact exceed—its expenditures. The NDP knows well that there is no budgetary need specifically for a “School Tax Surcharge” mainly hitting the Vancouver region.

People are also learning that this new tax, which is on track to kick in January 1st of the coming year and is not indexed for inflation, will impact far more people than initially represented—seniors who cannot afford to pay it, for example. Contrary to what was promised, many of them it turns out will not be able to defer onto the next generation the tax, as well as the interest charges the government will add to it, because no bank will issue to them or extend a mortgage—including to fund their needs in their old age—until this debt is paid.

But there is another consequence of the Surcharge that has commanded relatively little attention: the harm it does to renters, and to the small time landlords who provide them with housing.  The government has chosen to impose this onerous tax on owners of duplex and triplex rental properties, many of which are strata-titled, but not on big companies that have large rental buildings in excess of three units. According to the Canada Census, there were 63,145 rental units in duplexes in Metro Vancouver in 2016 (the year for which this data is available). Given that those living in these units range from singles to families with children, it is probably safe to assume that the population of renters in duplexes is at least 120,000 people in Vancouver alone.  To be sure, not all of these renters live in properties that will be hit by the Surcharge. But some of them do, and their number will rise significantly over time because the Surcharge is not indexed for inflation and will thus hit more and more duplexes in the coming years.

Landlords are increasingly vilified in our public discourse, but going after the small ones who provide two or three rental suites and exempting the big ones from the School Tax Surcharge will have a particularly ugly result for certain tenants. Some of the small time landlords who are affected by the Surcharge will be forced out of business while landlords with more than three rental units in their property will not have to pay it. There is a provision that allows landlords to apply for a special exemption to raise rents more than the allowed limit if they have “incurred a financial loss from an extraordinary increase in the operating expenses of the residential property.” If they are permitted to use this to pass along the School Tax Surcharge, some renters will face enormous rental hikes. However, it is unlikely that the government will allow landlords to use the provision to pass through this cost. This might seem like a blessing to renters, but in reality the consequences for some of them will be even worse: losing their home. 

This is because small time landlords generally lack the resources to sustain big losses. They have to dump the investments into which they have put their life savings and sweat equity because unlike a big corporation they cannot afford to ride it out and hope for better days. 

In some cases the Surcharge will double property taxes on a rental building. Imagine a case where the annual rent roll of a small rental building, net of the mortgage payment, is $30,000 and the Surcharge increases annual property taxes from $30,000 to $60,000 a year. A difficult situation (breakeven before maintenance and other ongoing expenses) is now made unsustainable with losses of $30,000 per year before any maintenance and repair costs. The small time property owner is forced into a sale in many cases far below assessed value. Ironically the School Tax Surcharge drives a long-term holder into precisely the kind of short-term sale the government has attacked as speculation.

So how does this negatively impact tenants? Very frequently in Vancouver, when duplexes and the like are sold, often either to developers or buyers with overseas capital, they get torn down and redeveloped into big new single family homes and, where new zoning permits it, fancy townhomes that are for sale, not rent. The widespread building of high end McMansions is precisely one of the phenomena that the NDP has decried in its talk of bringing down the price of housing. Yet by forcing small time landlords out of business, the School Tax Surcharge will eliminate existing supply of duplex and triplex rental units and actually cause them to be replaced by more big fancy houses and high end townhomes.

This is even more likely to occur if the provincial government tries to “patch” this discrimination against small time landlords by insisting that to avoid the Surcharge they agree with their municipality to have their rental property reclassified as “rental only” in perpetuity, even if it gets redeveloped. Few if any families who have put years of sweat equity and savings into a rental property would take this “offer” to escape the Surcharge falling on them.  Instead, fear that the government might make this zoning change a mandatory “offer that can’t be refused,” rather than optional, would very likely trigger a wave of selling of older small rental properties that currently are zoned for sale or rent, before the axe falls. These would then be torn down and redeveloped into brand new units—again, for sale, not rent. This will further reduce our supply of existing rentals, that in reality are much more affordable than the new for-sale housing that replaces them, and in fact even compare favorably to rents being charged on brand new rental units. The history of our dwindling and inadequate rental supply in Vancouver, choked by particularly onerous building requirements and permit delays, amply demonstrates that the more regulatory contortions and zoning constraints we try to impose in order to punish small time landlords and drive down the value of their investment, the more McMansions and luxury townhomes for sale will replace existing duplexes and triplexes and the less rental housing will be built.

The government claims that imposing this tax on small time landlords while exempting big ones from it is in order to prevent homeowners from fraudulently avoiding the Surcharge by converting their own home into a duplex or triplex and claiming it is for investment, not primary residence. This is a hollow argument, because primary residences are exempt from capital gains tax on their sale, while rental properties are not. As soon as a primary residence becomes an investment property, any gain in its value is subject to capital gains tax.  Revenue Canada is very clear about this: a property loses primary residence designation if its “income-producing use” is not “ancillary to the main use of the property as a residence”—a demonstrable and verifiable proposition that does not cover secondary suites or renting out a room in one’s home. If an owner later moves into one or more of the units of a duplex and reclassifies it as a primary residence in order to get the capital gains tax exemption upon sale, he or she must pay capital gains tax to the government on any increase in its value during the time it was classified as an investment. This is called a “deemed disposition”. 

Thus, anyone who tried to convert their home into an investment property for the sake of avoiding the School Tax Surcharge would be forfeiting an extremely valuable advantage—the capital gains tax exemption on sale of primary residence. They would lose this and have to pay a tax on any gain in the property value the minute they converted it back to a primary residence. Few rational people would do this, no matter how much they wanted to avoid the Surcharge being applied to their primary residence. If they did choose to “commit” this “fraud” however, the government would end up taking in more, not less, tax, due to the owner’s loss of exemption from capital gains taxes on sale of primary residence. And, on top of this higher tax revenue over time, the result of homeowners scurrying to transform themselves into small time landlords by offering duplex and triplex rentals would result in (wait for it…) more rental supply!

In George Orwell’s classic Animal Farm, the animals make many new rules in their catastrophic efforts to create a glorious social order of equality and banish oppression. One of these targets human beings: “Four legs good, two legs bad.”  In explicitly discriminating against existing duplexes and triplexes while exempting rentals of more than 3 units, the NDP’s School Tax Surcharge says “Four units good, two units bad.” Renters will be hurt as a result. 

We have ample and compelling historical examples of the dark path where misguided attempts at social engineering eventually lead us. This crippling and discriminatory tax on “bad” two-legged landlords but not the “good” four-legged ones must be lifted, lest we turn into that dystopian farm that Orwell so timelessly feared, and before a great many innocent animals are harmed by its unintended consequences.