If you’ve made an investment into anything profitable, from stocks, mutual funds, bonds, or real estate within the past year, you can claim the gains – or losses – as part of your tax return. If you do this the right way, you can balance your profits and losses to lower the amount of tax you owe. But before you can do that, we have to go over how capital gains work and what role they play in your tax situation.
- Capital gains are taxable, but only on half of the earnings, and these can be balanced with capital losses
- Capital gains on primary homes are NOT taxed, and certain categories of gains are exempt from tax
- Splitting capital gains with your spouse needs prior planning and a balanced investment from both individuals
What are capital gains and losses?
“Capital gains and losses refer, in essence, to the difference between purchase and sale prices for capital properties, as defined by the Canada Revenue Agency,” says Terry Baker, fellow chartered insurance professional with Investors Group in London, Ontario. “When the sale price is higher, you’ve earned a capital gain. When it is lower, you have a capital loss.”
In simple terms, anytime you invest your money into something that increases in value, that increase is considered a capital gain. For example, if you bought stocks for $50 a share and after a few months they’re valued at $52 a share, that’s considered a capital gain.
There are several types of capital properties that incur capital gains when you sell them. Common ones include:
- Stocks and bonds
- Units of a mutual fund trust
- Equipment used for a business
Overall, capital gains are a good thing; it means that your investment has been doing well and that you’re earning money through profitable returns. But there’s a flip side to this as well, known as capital losses.
A capital loss, as you might have guessed, is when your investment loses value over time. This means that your asset is worth less than when you bought into it, and is therefore a loss. Obviously, you’d want to avoid these as much as possible, but when investing, losses are sometimes unavoidable.
Since only capital gains are considered taxable, they should be your main priority. This doesn’t mean you should forget about capital losses though, as we’ll go over how you can use them to offset taxable capital gains later on.
How are capital gains taxed in Canada?
When investors in Canada sell capital property for more than they paid for it, Canada Revenue Agency (CRA) applies a tax on half (50%) of the capital gain amount. This means that if you’ve made $5,000 in capital gains, $2,500 of those earnings need to be added to your total taxable income.
The amount of tax you pay on your capital gains depends on how much income you’re making, and what type of earnings you have coming in. The more profit you make from different investments, the more tax you’ll need to pay.
There’s an important distinction the CRA makes between “realized” and “unrealized” capital gains. Your capital gains on any investment are considered unrealized and won’t be taxed until you sell them.
This means your capital gains will only be realized and taxable when you cash in your investment. So you won’t have to worry about filing for capital gains while your investment is still growing!
Using capital losses to offset capital gains tax
Capital losses mean that instead of profit, you actually lost money through your investments. If you do lose money during the year on your stocks, bonds, or other investments, you can claim them to reduce the amount of tax you pay on your profits.
Capital losses can be used against the capital gains of the same year, up to three years prior, or for future years depending on the situation. Also, you can use as much of your capital losses as you want to completely offset your capital gains.
This means that if you’ve had a bad investment year after a great one or vice versa, you can claim your capital losses in a year where you had a lot of profit. This cuts down how much tax you’d have to pay on your income from capital gains, which means more money in your pocket at the end of the day.
How to calculate a capital gain or loss
Calculating a capital gain or loss can be simplified into this formula:
Amount earned from asset sale – (amount spent on asset purchase + outlays and expenses) = capital gain or loss
Essentially, this takes how much you earned from the sale and subtracts how much you paid for it at the time of purchase along with any costs you had to pay to sell the asset. If the amount earned is higher than the amount you spent, then you’ll have a capital gain. And if the opposite is true, then you’ve incurred a capital loss.
Let’s consider an example. David decides to buy 150 shares of stocks for $15 per stock with no purchase fees. A year later, he decides to sell 75 stocks for $10 each. Another year after that, he sells the remaining 75 shares for $20 each. Each time David sells his shares, he pays $100 in broker fees.
The first year, David sold 75 shares x $10 per share, which equals $750. From this amount, we’ll remove the original value of the 75 shares at $15 each, which is $1,125. We’ll also remove the $100 he spent on broker fees for the sale.
$750 – $1,125 – $100 = $-475
This means that in the first year, David lost money and had a capital loss of $475.
Now let’s repeat this for the second year. David sold the remaining 75 stocks for $20 each, which equals $1,500. Once again we can remove the original value of those 75 shares ($1125) and $100 in broker fees for the sale.
$1,500 – $1,125 – $100 = $275
In the second year, David made a capital gain of $275.
So how does this apply to David’s tax situation? Since David had a loss of $475 in the first year, he can carry that loss forward and deduct it from his gains to avoid being taxed on them. When he does this, it removes his gain amount from the loss:
$475 – $275 = $200 in capital loss
Now, David has used his capital losses from the first year to offset the capital gains in his second year, and he still has another $200 that he can claim against any gains next year and reduce the taxes he pays on them.
Capital gains on principal residence
If you’re like most Canadians, your home is your biggest asset. When the time comes to sell, you hope to get a good return on your investment. Unlike stocks & bonds, profits made from selling your family home (i.e. principal residence) are usually exempt from tax. You’ll still report the sale during the year it was made, but any profit you make from your primary residence won’t be considered capital gains. However, there are a few situations that will trigger capital gains including:
- Your home hasn’t been your principal residence for all the years you’ve owned it, or
- You’ve used part of your home for income (business or rental)
You might also need to pay for capital gains during the time your home wasn’t the primary residence, which you’ll need to calculate using form T2091.
If you’ve rented out a part of your home, like the basement or a secondary suite, you might also be on the hook for capital gains from the section that was rented out. The CRA has a full guide on how you can calculate this.
Capital gains when day trading in Canada
Day trading is the process of buying and selling stocks quickly multiple times throughout the same day. This allows you to make money on the small increases and decreases in price that happen on the stock market regularly.
Many Canadians make their living off day trading, and it’s considered a full-time job even though you’re making capital gains off investments through stocks. As a result, if the CRA considers you a day trader, your trade earnings are considered income, not capital gains, and will be taxed accordingly, which saves you a lot of money in the long run.
However, keep in mind that the CRA carefully scrutinizes your earnings and makes their own decision on whether you’re considered a day trader or a more casual investor. It’s a good idea to keep records of your trades so that you can provide necessary paperwork when the time comes.
Is there a capital gains exemption in Canada?
There are three different property types that are considered qualified for this exemption:
- Qualified Small Business Corporation Shares: Any private company shares in an organization that does active business and is owned by Canadians. You’ll need to make sure that you or a family member has owned these shares for at least 2 years for them to count. Also note that publicly listed companies or mutual funds aren’t valid here.
- Qualified Farm Property: Properties such as buildings, land, and milk and egg quotas that are used in a farming enterprise. Any shares from a company that operates a farm will also be within this group.
- Qualified Fishing Property: This covers real estate for fishing purposes, fishing vessels, and fishing licenses. Again, if your fishing business is operated through a company, their shares count as well.
On top of these, you might have capital gains in reserve, which means that you earn them over a period of years instead of all at once. The amounts you haven’t received yet are also considered exempt.
But any other investments that don’t meet one of these categories can’t be exempt from capital gains tax. This makes it extra important to balance your capital gains and losses where you can to reduce the amount you’ll owe.
Can I split my capital gains with my spouse?
Many Canadians consider splitting their capital gains with their spouse as a way to reduce the amount of tax they’d owe on their returns. But this might not be as foolproof as you’d think.
The simple answer is that you can’t just split your capital gains in half between you and a spouse.
How much of your capital gains you can split with your spouse depends on two factors:
- Whether you shared the investment costs at the beginning
- How much your spouse contributed.
If you invest 100% of the total amount towards a venture and make capital gains from it, these gains are yours, even if you handed that investment to your spouse. You can’t just hand over investments or split them between the two of you to avoid capital gains.
To properly split capital gains with a spouse, you need to divide the investment right from the start. For example, let’s say you bought 200 shares of stock, with you paying for 100 and your spouse paying for the other 100. When you sell the shares and make a profit, you can claim 50% of the capital gains while your spouse would claim the other 50%, since you each bought half of the shares when buying.
So what does this mean? If you want to split your capital gains with your spouse, you’ll need to plan ahead before making the investment. Consider how you would like to split the money you’re putting in and try to get paperwork for future reference. This’ll make it easy to back up your split claim when you decide to sell the investment for profit.
Three tips on how to reduce your capital gains tax
We’ve covered a lot of info on capital gains and how they affect your taxes. Now that we have a clear understanding of how they interact with losses and apply to specific situations, lets go over our three biggest tips on how you can reduce your capital gains tax:
1. Use capital losses to offset your capital gains
Our example above should have given you a good understanding of how capital losses can be used to offset any gains you make during the tax year and effectively reduce how much tax you’d need to pay on them. Remember that capital losses can be carried forward and applied to future years, so keep track of your investments and make sure to claim your losses at the right time to maximize your return amount.
2. Invest through a tax-advantaged account like a TFSA
If you’re an average investor but want to avoid capital gains when trading stocks, then using a TFSA or other tax-advantaged account can help you avoid taxes on your earnings from trading. Since TFSA account earnings are non-taxable, they’re considered income instead of capital gains, which means you’re paying a lot less tax on them.
3. Sell your assets when your income is low to minimize the tax your pay
Your capital gains are calculated according to your personal tax bracket, which means that if your income for the year pushes you into a higher bracket, you’ll effectively be paying more tax on your capital gains as well. The opposite is also true; if your income for the year was reduced for any reason (due to job loss, a work transition, etc.) then you can take the opportunity to sell your assets while your income is under a lower tax bracket. This lets you lower the percentage of tax you pay on those capital gains and saves you more money in the long run.
File with TurboTax Premier
If you’re still trying to make sense of your capital gains for the tax filing season, TurboTax has your back. With TurboTax Premier, you’ll get access to step-by-step guidance on capital gains and loss during while filing. Whether you’re looking at capital gains from stocks, bonds, crypto, or rental property income, we’ve got everything you need to file the right forms and maximize your return.
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