In 2023, the federal government expanded the HST rebate for purpose-built rental housing. This policy was subsequently matched provincially in Ontario and a few other provinces. The policy was straightforward in its intent. If governments want more rental homes, especially in high-cost cities, reducing taxes on new rental construction is one of the most direct ways to encourage private investment.
Prior to this policy, upon completion of a new residential rental building, the developer would have to self-assess the value of the completed building and write a 13 percent (in Ontario) cheque to the Canada Revenue Agency.
In principle, eliminating this punitive tax on new housing through a rebate makes sense. In practice, one aspect of how the rebate is written and interpreted is creating an unintended but meaningful problem.
Under current legislation and the way it is applied by the CRA, two projects that produce the same amount of new rental housing can be treated very differently for tax purposes.
Consider a simple example.
A developer buys a single-family house and replaces it with a small five-unit multiplex. If the original house is fully demolished and the new building is constructed entirely from scratch, the project is considered new construction and qualifies for the full HST rebate.
However, if the same developer keeps any portion of the existing structure (a part of the foundation or an exterior wall) and then builds the same five rental units, the project would then be classified as a major renovation. In that case, the HST rebate is denied.
From a housing perspective, the outcome is identical. One detached house is removed, and five new rental units are added. From a tax perspective, the difference can be substantial (an approximately $200k to $400k tax bill).
Why this distinction matters
The distinction between new construction and major renovation might sound technical, but it has real consequences.
In many small infill projects, retaining parts of an existing building is not about cutting corners or preserving aesthetics. It is often the most practical option. Existing foundations may be structurally sound. Site conditions or zoning rules may make partial retention simpler. In some cases, keeping a portion of the structure can reduce costs, shorten construction timelines, and limit disruption in established neighbourhoods.
Canada’s federal HST rebate for purpose-built rental housing, intended to boost rental supply, has an unintended consequence. The policy differentiates between new construction and major renovations, denying the rebate if any part of an existing structure is retained. This penalizes practical, cost-effective methods for building “missing middle” housing, such as multiplexes, by imposing significant tax bills ($200k-$400k). Developers, especially those in existing neighbourhoods, are pushed towards complete demolition, even when partial reuse is more efficient. This misaligned incentive discourages crucial small-scale rental development, impacting supply where it’s most needed and surprising builders after projects are completed.
Should tax policy prioritize housing outcomes over construction methods?
How does this policy unintentionally hinder 'missing middle' housing?
What are the potential long-term consequences of this misaligned tax incentive?
Comments (5)
My understanding in Ottawa is that retaining part of the current structure is done to avoid the development charges the city levies on new construction. At least that’s how 2 residential conversions across the street from me in downtown Ottawa were explained by the developer eight years ago. These conversions cut down mature trees, extended the structures to the lot lines on both sides and crammed 4 apartments into each enlarged structure by bringing the new basements half out of the ground and adding 3 stories on top. Only 2 parking spaces are provided for each building. The developer then sold these new buildings to foreign investors and they are managed by a property management company. The extra demands on street parking, and the additional noise and garbage from the transient tenants, have degraded the quality of life on our short residential street. If this is what is meant by “increasing rental supply”, then the public will not support it. Based on this experience, my own naive faith that governments actually know what they are doing is no more. And, since then, Ottawa has also gained fame for the rollout of its disastrous LRT system which has severely degraded our once functional and reliable mass transit system.