[Tax Story] The History of Real Estate Taxation and the Wisdom of an Old Horse Recognizing the Way

Baek Jeheum, Lawyer at Kim & Chang

There was a recent report that reverse jeonse, where homeowners pass on the increased taxes to tenants, has become popular due to the rise in holding taxes following the December 16 real estate measures last year. According to one statistic, the proportion of reverse jeonse contracts surged from 8.9% in September last year to about 16.4% in December when the real estate measures were announced. These real estate measures include raising the comprehensive real estate tax rates, increasing capital gains tax rates, and lowering deduction rates, with the official housing prices being rapidly adjusted to 70-80% of market prices. As the nationwide standard land official price increase rates sharply rose from 4.94% in 2017, 6.02% in 2018, to 9.42% last year, some local governments have even requested the Ministry of Land, Infrastructure and Transport to lower the official land prices. The Local Tax Act has also been amended to cooperate with the policy direction by raising acquisition tax rates for multi-home households when purchasing houses. South Korea’s real estate tax system is aggressively targeting housing prices through both national and local taxes, and as a result, unpredictable ripple effects are being observed in housing transaction methods.

The taxation triggers in the real estate tax system can be broadly divided into three stages based on housing: acquisition, holding, and disposal. First, acquisition generally incurs an acquisition tax of 1-3%. If the acquisition is due to gift or inheritance, gift tax or inheritance tax is additionally imposed. Next, during the holding stage, property tax and comprehensive real estate tax are levied. Property tax is a local tax imposed annually based on the official price as of June 1. The tax brackets are finely divided at 60 million KRW, 150 million KRW, 300 million KRW, etc., with rates ranging from 0.1% to 0.4%. The national comprehensive real estate tax is also imposed annually as of June 1 on the amount exceeding the deduction threshold for houses valued at 600 million KRW (900 million KRW for single-home households). The taxable base exceeding the threshold is divided into six stages at 300 million KRW, 600 million KRW, 1.2 billion KRW, 5 billion KRW, and 9.4 billion KRW, with rates ranging from 0.6% to 3.0%. Higher rates apply if owning three or more houses or two or more houses in regulated areas. When disposing of a house for consideration, capital gains tax is imposed with a progressive seven-tier rate of 6-42% based on taxable income thresholds of 12 million KRW, 46 million KRW, 88 million KRW, 150 million KRW, 300 million KRW, and 500 million KRW. It is important to note that acquisition tax and capital gains tax are based on actual transaction prices, while property tax and comprehensive real estate tax are based on official prices.

Since the introduction of the first "Special Measures Tax on Real Estate Speculation" in November 1967, South Korea has employed various tax measures to stabilize real estate prices. After the real estate price surge following the 1988 Seoul Olympics, the "Land Overholding Tax," considered the precursor to the comprehensive real estate tax, was implemented in December 1988. In January 1990, the "Comprehensive Land Tax," which consolidated the land portion of property tax and the land overholding tax, was established. From January 2005, the comprehensive real estate tax, a variant of the so-called comprehensive property tax discussed since the late 1970s, was legislated, and the existing comprehensive land tax was integrated into property tax. Additionally, taxation on capital gains from real estate transfers has been gradually strengthened. The first income tax law after the establishment of the government did not tax capital gains from real estate transfers. After several amendments, capital gains from real estate transfers were firmly established as taxable income with the 1975 revision of the income tax law into a comprehensive income tax system. However, despite these tax reforms, real estate speculation was not eradicated, and prices continued to rise. The record of tax policies aimed at curbing speculation has been quite poor. Various reasons have been analyzed, but the most plausible is the result of the law of supply and demand, Adam Smith’s "invisible hand." Housing demand, especially in the metropolitan area, has increased, but housing supply has consistently fallen short of that demand.

Regulatory taxes aimed at curbing real estate speculation have continuously clashed with the constitutionally guaranteed fundamental rights of citizens. In 1994, the Constitutional Court ruled the Land Excess Profit Tax, which imposed a 50% tax rate on idle land and non-business-use corporate land to capture gains from land price increases, unconstitutional for violating Article 23 of the Constitution, which guarantees private property rights. In 1999, the law limiting land ownership regardless of acquisition method or purpose was ruled unconstitutional for violating the principle of minimal infringement. In 2008, provisions of the Comprehensive Real Estate Tax Act requiring household aggregation were ruled unconstitutional for violating Article 36, Paragraph 1 of the Constitution, which prohibits discrimination due to marriage. As the Constitutional Court has indicated, imposing uniform and indiscriminate high progressive taxation without considering ownership motives, duration, taxpaying ability, or other assets and income beyond real estate exceeds the necessary policy means to achieve legislative goals and infringes on taxpayers’ constitutional fundamental rights.

It is clear that rampant real estate speculation undermines healthy work motivation and excessively high housing prices hinder young people’s future planning, making it an urgent national issue. Few dispute the cause of promoting middle-class housing stability by minimizing housing price increases. However, housing prices are ultimately determined by the economic principles of supply and demand, and relying on regulatory taxes to stabilize real estate prices is likely to be a fleeting dream. The traditional purpose and function of taxation is national revenue collection, so if taxes are used solely as policy tools, there is a risk of them degenerating into so-called "sin taxes," undermining the tax system’s foundation. Research also suggests that excessive capital gains taxation can freeze housing supply through consolidation and freezing effects, ironically contributing to housing price increases. Moreover, maintaining high capital gains taxes while only increasing holding taxes may infringe on the essential parts of private property rights. Holding taxes are levied on unrealized valuation gains, making liquidity difficult and true taxpaying ability hard to assess. For example, the taxpaying ability of someone who bought a 1 billion KRW house long ago for 100 million KRW cannot be the same as someone who recently purchased it for 1 billion KRW, nor can the ability of a person who bought with their own capital be the same as one who bought with bank loans. The wisdom to achieve both citizens’ housing stability and fair tax burden may truly be found in Adam Smith’s "The Wealth of Nations" written centuries ago.

Baek Jeheum, Attorney at Kim & Chang