The Basics of Claiming Capital Gains and Losses

What is capital property?

Capital property is any asset you own that can generate a capital gain or loss when you sell it. These properties are typically held for investment purposes or to earn income. Some common examples include:

• vacation homes or cottages that are not your principal residence
• stocks, bonds, and units of mutual fund trusts that are not held in a registered account, like a Registered Retirement Savings Plan (RRSP)
• land, buildings, and equipment used in a business or rental operation

Note: Your business's trading assets, like inventory, do not count as capital property.

Understanding capital gains and losses

You realize a capital gain or loss when you sell or are considered to have sold your capital property. You might be wondering what “considered to have sold” actually means. One common scenario where this applies is when you give property (other than cash) as a gift.

Before we get into the details of how to calculate these gains and losses, you need to know the following 3 amounts:

1. Proceeds of disposition. The sale price of your asset.
2. Adjusted cost base (ACB). The original purchase price plus any additional costs incurred to acquire the property, such as commissions and legal fees.
3. Outlays and expenses. The amounts you incur to sell your assets, such as brokerage fees, legal fees, and commissions.

Using these amounts, you can calculate your capital gain or loss with this formula:

Capital gains/Losses = Proceeds of disposition - (ACB + Outlays and expenses)

You incur a capital gain when you sell an asset for more than its ACB, plus any expenses related to selling it. Imagine you bought shares in a tech company 2 years ago for $1,000 (ACB) and paid $50 in brokerage fees (outlays). Recently, you sold those shares for $1,500 (proceeds of disposition).

Your capital gain = $1,500 - ($1,000+$50) = $450 (gain)

So, you made a $450 profit from selling your shares.

On the other hand, you have a capital loss when the asset's sale price is less than its ACB, plus any costs related to selling it.

Now, let's say the company didn't do well, and you sold the shares for only $700 (proceeds of disposition).

Your capital loss = $700 - ($1,000+$50) = $350 (loss)

In this case, you incurred a $350 loss from selling your shares. This loss can be used to offset taxable capital gains in the same year, 3 preceding years, or carried forward to reduce gains in future years.

What is the capital gains tax rate in Canada?

While capital gains are taxable in Canada, there's no single “capital gains tax rate.” Instead, a portion of your profit is added to your income and taxed at your marginal tax rate. So, your capital gains tax rate depends on where you fall within the provincial and federal income tax brackets in the year you report the gain.

How to determine your taxable portion

The inclusion rate—the portion of your capital gains that are taxable—is set at 50%. This means if you made $10,000 in capital gains, only $5,000 would be added to your taxable income. This rule is applied uniformly, regardless of the total amount of capital gains you earned.

How to minimize your capital gains tax

Paying taxes on your investment profits may take a significant bite out of your earnings. Here are some ways to reduce your taxes.

1. Offset your capital gains with capital losses

If you have a capital loss, you can use it to reduce your capital gains for the same year. For example, if you earned $5,000 in capital gains but also incurred a $3,000 capital loss, you can subtract the loss from the gain. This would leave you with a taxable capital gain of $2,000 for the year.

If your capital losses exceed your gains, the remaining amount becomes a net capital loss. For instance, if your losses totalled $7,000 while your gains were $5,000, you would have a net capital loss of $2,000.

You can use a capital loss amount to lower the taxable capital gains for any of the 3 preceding years or carry forward indefinitely to offset future gains.

It's important to note that capital losses cannot be used to offset other types of income, such as employment income.

2. Use tax-advantaged accounts

Investing through tax-advantaged accounts like Tax-Free Savings Accounts (TFSA), Registered Retirement Savings Plans (RRSP), First Home Savings Accounts (FHSA), and Registered Education Savings Plans (RESP) is an easy way to avoid capital gains tax. Let's take a closer look at these tax-sheltered accounts.

• TFSA: Your investment gains and withdrawals are completely tax free.
• RRSP: Contributions are tax deductible, and investments grow tax deferred until withdrawal.
• FHSA: Contributions are tax deductible, profits aren't taxed, and you can make tax-free withdrawals for qualifying withdrawals.
• RESP: Investments grow tax-deferred. When funds are withdrawn for educational purposes, the government grant and investment growth portions are taxed at the student's income level, which is usually low. The principal (your contributions) is not taxed upon withdrawal.

If you realize a capital gain and have available contribution room in your RRSP, you can contribute the profit to your RRSP. Doing so can reduce your taxable income for that year, since contributions to an RRSP are tax deductible.

3. Apply for a capital gains deduction

Certain types of capital gains qualify for a lifetime capital gains exemption (LCGE), which can significantly reduce your taxable income. You may be eligible for the LCGE under the following conditions:

• you sell shares of a qualified small business corporation (QSBC)
• you sell a qualified farm or fishing property (QFFP)
• a trust allocates taxable capital gains from a QSBC or QFFP

This LCGE is the total amount of capital gains that you can realize over your lifetime without having to pay taxes on them. Currently, this exemption is set at $1,250,000. Since only 50% of capital gains are taxable, the maximum deduction under the LCGE is $625,000.

4. Claim a capital gains reserve

When you sell an asset, you usually get paid in full at the time of sale. But sometimes, the payment is spread out over several years. Let's say you sell a property for $50,000 and get $10,000 upfront and the remaining $40,000 over the next 4 years.

In cases like this, you can claim a capital gains reserve to report only the part of the capital gain that you actually receive each year instead of the entire gain all at once. By distributing the capital gain over several years, you can potentially avoid moving into a higher tax bracket in any single year.

To deduct a reserve, you must complete Form T2017, Summary of Reserves on Dispositions of Capital Property. Most reserves can be claimed for up to 4 years, but a 9-year period applies for:

• transfers of family farm or fishing property to your child
• transfers of small business corporation shares to a child family member
• gifts of non-qualifying securities to a qualified donee

How to report capital gains and losses on your tax return

You must report the sale of an asset in the calendar year (January to December) in which you sell or are considered to have sold it. Whether you have a capital gain or loss, you must report the transaction on your tax return.

The sale of assets is reported on Schedule 3, which includes manual entries, such as a real estate disposition, as well as amounts that may be reported on the following slips:

• T3, Statement of Trust Income Allocations and Designations
• T5, Statement of Investment Income
• T5008, Statement of Securities Transactions
• T5013, Statement of Partnership Income
• T4PS, Statement of Employee Profit-Sharing Plan Allocations and Payments

After completing Schedule 3, you will get the total capital gains or losses on line 19900. If the amount is positive, enter it on line 12700 of your T1 General tax form. This represents your net capital gains. If the amount on line 19900 is negative (indicating a loss), do not enter it on line 12700. The CRA will register this loss in their system.

If the asset is held outside of Canada, such as in the U.S. or another country, convert all amounts—proceeds, costs, and expenses—into Canadian currency when reporting the sale on your personal tax return. Use the exchange rate that was in effect on the day of the transaction.

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