There’s a lot to learn when you start investing, and it’s not just a question of what stocks to pick. A key part of earning money on your investments is understanding how things work when you sell—and that means understanding capital gains. Knowing what capital gains (and losses) are and how they affect your income taxes is crucial if you want to make smart investment decisions, maximize your returns, and avoid costly mistakes.
Here’s the 101 on how capital gains tax can affect you personally.
- Real estate counts as capital property and is subject to capital gains tax when you sell.
- Some kinds of capital property, like your primary residence, are exempt from capital gains tax.
- There are a few ways you can reduce how much capital gains tax you have to pay, like investing in a sheltered account and making use of capital losses.
What is the capital gains tax rate on real estate and home sales?
Real estate and home sales are taxed like any other capital gain—unless the home you’re selling has always been your principal residence, in which case you wouldn’t have to pay any capital gains tax at all.
However, if you have ever used any part of your home to earn an income, there is a possibility you will have to pay capital gains tax on that income-earning portion of your home. This might be calculated based on time (say, you rented it out for one out of the 10 years you owned it) or area (you rented out the basement suite, which is 35% of the total floor space). The CRA has a good explanation of how this works.
If the home in question is subject to capital gains—for instance, it’s your second home, a cottage, or a piece of land, and you earned a profit—calculate your profit and divide it in half. That amount is then taxable as income, just like your salary, investment interest, and any other money you earn. A common misconception is that you have to pay half the capital gains as tax. But you only have to pay tax on half of the capital gains.
It’s a three-step process:
- Calculate the profit.
- Divide the profit in half (or multiply it by 50%).
- Apply your personal tax rate.
Example: How you’re taxed on real estate capital gains
Let’s say you sold some real estate (not your primary residence) for $750,000. Your total cost, including what you paid for it and any other eligible expenses, was $650,000.
Tip: when you add together the amount you paid for capital plus expenses you’re allowed to claim as part of that cost—think legal fees—this total is known as the adjusted cost base, or ACB.
Take your cost and subtract it from your sale price, and this is what the math looks like:
$750,000 – $650,000 = $100,000
That’s $100,000 in capital gains. Then, you divide that amount in half to get the taxable capital gains:
$100,000 x 50% = $50,000
That means you have to pay tax on $50,000 in capital gains. In other words, you add $50,000 to your total taxable income for that year. How much of that $50,000 you eventually have to pay depends on your total taxable income and any deductions (like RRSP contributions) or capital losses that you may have available to claim.
For example, if your tax rate for the year works out to be 33%, you’d pay this much in capital gains tax:
$50,000 x 33% = $16,500
As a reminder, your total capital gain in this hypothetical example was $100,000. In other words, hypothetically you paid $16,500 in tax on a $100,000 profit, leaving you with a nice chunk of change left over:
$100,000 – $16,500 = $83,500
Can you be taxed on capital gains on the sale of land only?
Yes, because it’s capital property. Let’s look at some more numbers.
Imagine you bought a property on the New Brunswick coast with plans of building your dream home. You paid $100,000 for this chunk of land. Unfortunately, you’ve realized the dream is out of reach, and you have to move on. Luckily, the market is up and you’re able to sell for $160,000. Nice!
The next step is to calculate your profit. To do this, add up your cost—which includes not just what you paid for the property, but the real estate agent fees and legal fees, or ACB, as defined above.
Let’s say the total other costs are $10,000. The math might look like this:
- ACB: $100,000 (price of land) + $10,000 (other costs) = $110,000
- Profit: $160,000 (earnings on the sale) – $110,000 (ACB) = $50,000
In other words, your total capital gains for selling your little slice of New Brunswick come to $50,000.
Now we come to step 2. We know that only half of the capital gains are taxable. So we take our profit and multiply it by 50%:
$50,000 (profit) x 50% = $25,000
And there you have it: $25,000 to include in your taxable income for that calendar year. How much of that $25,000 you eventually have to pay depends on your total taxable income and any deductions or capital losses you have available for that tax year.
How are the capital gains on stocks taxed?
When you sell stocks for more than you paid for them, you end up with capital gains—and you have to pay tax on that profit. How this is calculated is similar to real estate:
- Subtract cost from earnings to find out the total profit.
- Divide that profit in half to get the taxable capital gains.
- Add the taxable capital gains to your annual personal income and pay tax based on that total amount.
What does this look like with real numbers? Let’s say you own 100 shares in Big Awesome Company Inc. You paid $10 per share when you bought them, and you sold at $15. In addition, the purchase cost you $100 in commissions and fees. Here’s how that maths out:
- Purchase cost: 100 x $10 = $1,000
- Adjusted cost base (ACB): $1,000 + $100 = $1,100
- Proceeds: 100 x $15 = $1,500
- Profit: $1,500 – $1,100 = $400
When you take all costs into account, your profit on the sale of these shares is $400. That’s $400 in capital gains.
But remember that you only pay tax on half of your capital gains, so you can divide that amount in half:
$400 x 50% = $200
That means that for this stock sale, you add $200 to your taxable income for the year. What is the capital gains tax rate on that $200? That depends on what the rest of your tax return looks like: your total income, your deductions, and other factors.
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How do I avoid capital gains tax in Canada?
You know the saying: the only two sure things in life are death and taxes. But while you can’t avoid taxes completely (and they haven’t invented an immortality pill yet), there are some—completely legal—methods to lower what you have to pay. Here are three big ways you can reduce your capital gains tax:
1. Use capital losses to offset your capital gains
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. One very handy thing about capital losses is you can use them to offset capital gains in other years, too—not just the same year the loss occurred. Not only can you carry the losses forward for as long as you need to, but you can apply them retroactively up to three years in the past.
For example, in 2021 you paid tax on capital gains, and in 2022 you had only capital losses. Even though you filed taxes for 2021, you can still submit paperwork to apply those 2022 capital losses to the 2021 capital gains and reduce your 2021 income tax (get more money back from the government).
The same goes for the future. If you have a $20,000 capital loss in 2022, you can save that loss and use it in future years. For example, in 2024 you sell your cottage for $100,000 and have to pay capital gains tax on the earnings. Assuming you haven’t used it yet, you can apply that 2022 loss of $20,000 to the 2024 capital gain:
$100,000 (2024 capital gain) – $20,000 (2022 capital loss) = $80,000
Divide that in half and you’ve got to pay tax on just $40,000 out of your $100,000 in profit.
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 Tax-Free Savings Account (TFSA) or another tax-advantaged account can help you avoid taxes on your earnings from trading.
3. Sell your assets when your income is low to minimize the tax you 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 a 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.
Armed with as much knowledge as possible on capital gains tax as well as learning some tricks of the trade should put you well on your way to successfully maximizing your capital gains opportunities and shortfalls for your tax filing season.
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