[Public Voices] Abolishing the Long-Term Holding Special Deduction... The Beginning of Rational Tax Reform

Jun Park, Professor at the University of Seoul

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The long-term ownership special deduction for capital gains tax is drawing attention. I also agree that a reasonable adjustment to this unique mechanism is necessary. Korea's real estate tax system is replete with exceptionally intricate, and at times even ingenious, measures to alleviate tax burdens. These are likely the result of the diverse demands of stakeholders over a long period. Among these, the long-term ownership special deduction for capital gains tax stands out.

The capital gains tax was introduced in 1967 under the Park Chung-hee administration as a representative anti-speculation tax, with a 50% tax rate levied on profits from land sales, aiming to curb real estate speculation and recover unearned income. However, over time, the original purpose became blurred, and the tax has devolved into a temporary means for government intervention in the real estate market.

The special deduction for capital gains, introduced in 1975 under the pretext of offsetting inflation, was merged in 1995 with the long-term ownership special deduction, which had been introduced in 1989. The deduction rate for long-term ownership of a single home was expanded to a maximum of 45% for over 15 years of ownership during the Roh Moo-hyun administration in 2006. Subsequently, the Lee Myung-bak administration raised it to a maximum of 80% for over 20 years of ownership in 2008, and in 2011, the period for the maximum 80% deduction was dramatically shortened to more than 10 years. The Moon Jae-in administration, in 2021, separated the deduction into a maximum of 40% for over 10 years of ownership and a maximum of 40% for over 10 years of residence. However, the total period of more than 10 years and the maximum combined deduction of 80% are still maintained today.

A look at the structure and rationale of the long-term ownership special deduction quickly reveals its problems. The deduction for a single home currently applies only when the sale price exceeds 1.2 billion won, which is the threshold for high-priced homes; for homes sold below this threshold, capital gains tax is exempt. There is also no limit on the number of times the exemption can be used. This means that for single homes priced at or below 1.2 billion won, one can repeatedly buy and sell and all capital gains are tax-exempt. There is one more relief mechanism: the "taxable ratio," which reduces the taxable portion of the capital gain. The taxable ratio is calculated as "(sale price - high-priced home threshold) / sale price."

For example, suppose someone purchases a home for 500 million won, lives in it for 10 years, and then sells it for 2 billion won. The sale price of 2 billion won exceeds the high-priced home threshold of 1.2 billion won, so it is subject to tax. The capital gain is 1.5 billion won (2 billion won - 500 million won), but the taxable ratio is 40%, making the taxable capital gain 600 million won (40% of 1.5 billion won). Applying the 80% long-term ownership deduction to this amount, 480 million won (80% of 600 million won) is deducted, reducing the taxable income to 120 million won.

In other words, the 1.5 billion won capital gain is reduced to 120 million won for tax calculation purposes. The final taxable base is 120 million won, and with a tax rate of 35% and a progressive deduction of 15.44 million won, the capital gains tax becomes 26.56 million won. Although the nominal tax rate is 35%, thanks to the 1.2 billion won high-priced home threshold and the "magic" of the long-term ownership deduction, the effective tax rate (the ratio of capital gains tax to capital gain) falls below 1.8%. In reality, including the basic deduction of 2.5 million won and any allowable expenses, the effective rate is even lower.

The justification for the long-term ownership deduction for single homes exceeding the high-priced threshold of 1.2 billion won is to prevent a situation where, after selling one’s current home and paying capital gains tax, it becomes difficult to buy another home under similar conditions. However, since this deduction applies to so-called "high-priced homes" and poses an issue of fairness for those without homes, it is difficult to avoid criticism for being excessive. During the Lee Myung-bak and Park Geun-hye administrations, the deduction was granted up to 80% based solely on ownership, regardless of residence; even now, up to 40% is allowed, which is far removed from the original justification.

Another noteworthy point is that, for those owning multiple homes and for land and buildings, a maximum deduction of 30% is allowed for ownership of 15 years or more. This is justified as compensation for inflation. But for what other assets, aside from real estate, is such inflation compensation provided? Unless the true purpose is to stimulate the real estate market and boost prices, this is difficult to justify.

I advocate for abolishing the long-term ownership special deduction. Instead, I propose allowing, in the case of actual residence in a single home, a deduction from capital gains tax-up to a 40% cap-of the amount of property holding tax paid during the period of residence. By reflecting the property holding tax in this way, the longer one resides, the more holding tax is accumulated, meaning the benefits of long-term residence are realized without needing an excessive long-term ownership deduction. Under this reform, if the property holding tax is low, the subsequent capital gains tax would increase; conversely, if the property holding tax is high, the capital gains tax would decrease, thereby maintaining a balanced tax burden and reducing tax resistance. It is also worth considering changing the high-priced home threshold-which at 1.2 billion won is similar to the median price of apartments in Seoul-to, for example, twice the national median home price (currently about 300 million won), and converting this into a basic deduction for single homes, limiting its use to perhaps twice in a lifetime.

There is growing consensus about the negative impact of excessive focus on real estate and rising prices on the overall economy and future generations. It is time to rationally adjust the various unreasonable tax relief mechanisms within the real estate tax system based on the principle of tax fairness. Abolishing the long-term ownership special deduction for capital gains tax and linking property holding tax to capital gains tax assessment could be the start of such rational adjustments.

Jun Park, Professor at the Graduate School of International Urban Science, University of Seoul

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