Including the family home in the pension asset test or allowing retirees to use its equity would help make Australia’s taxation system more fair, and unlock the $926bn worth of home equity held by older Australians, a new report has found.

Ending the exemption of the principal place of residence in the eligibility for the age pension would see nearly 360,000 lose the entitlement, netting the government about $6bn a year, the landmark productivity commission report found.

“In principle, including the full value of the principal residence in the age pension assets test would improve efficiency and equity,” the commission said. “At a minimum, there is a strong case on equity grounds for setting limits on the value of the principal residence that is exempt from the age pension means test.”

But the commission noted that any change could not happen straightaway.

“Given that support for home ownership is embedded in many government policies and in people’s retirement planning, removing the exemption entirely in the immediate future is intractable,” it said.

Three out of four Australians who access the age pension own their homes.

Retirees are relying too heavily on the pension, which puts an increased burden on existing taxpayers, raising questions about “intergenerational equity”, the report said.

The report into housing decisions by older Australians, released by the productivity commission on Tuesday, found that retirees often engage in “precautionary savings” by spending less than their age pension, even when this is detrimental to their quality of life.

Many do this because of a “strong aversion to debt in old age”.

It recommended that retirees be able to benefit from the equity of their property, and purchase reverse mortgages that allow them to turn that equity into cash.

“Most older Australian home owners on low incomes could achieve a modest retirement living standard over the remainder of their lives by drawing on their home equity,” the report said. “Older Australians strongly prefer to age in place. Most people are happy staying in their family home, despite a common perception that such homes are too big for them.”

Many choose not to sell and move into smaller dwellings.

“There is a general lack of affordable downsizing options for older Australians, due in large part to the red tape and inconsistencies within state and territory land planning regimes,” the report said.

But enacting stamp duty concessions for pensioners would create inequity in the population and a funding shortfall for state and territory governments, for whom the tax amounts to one-quarter of revenue.

The Property Council wants governments to give retirees more options for downsizing their homes without jeopardising their age pension.

“Reforms to remove the penalty pensioners face when looking to downsize must be a priority for government,” its executive director, Mary Wood, said. “Tightly targeted reform, like the one we have previously put forward, allowing eligible pensioners to choose the most age-appropriate accommodation and unlock the equity in their family home will benefit seniors and the broader economy.”

The then social services minister, Scott Morrison, tightened eligibility for the part-pension just before the May budget, reducing the value of assets from $1.5m to $823,000 – apart from the family home – that a couple can hold while still receiving the part pension.

That would save $2.4bn over four years, about a tenth of the revenue that the productivity commission estimates would be raised from including the family home in the asset test.

Morrison, now treasurer, ruled that out in May. “The family home will not be included in the assets test and never will under a Coalition government,” he said.