Capital gain – those two words may inspire confusion amongst some taxpayers. But in fact, earning a capital gain can very advantageous. Unlike income from a business or salary, only half of a capital gain is taxable, whereas you pay income tax on the totality of your ordinary income. Even better, in some cases, capital gains are not taxable at all. So how do you go about earning capital gains, and what do you do with them?

The proceeds of a sale are often taxed as a capital gain.

The proceeds of a sale are often taxed as a capital gain.

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“One of the best aspects of selling your business is that, if you structure the sale correctly, you may not owe any income tax on your profits. That’s good news for entrepreneurs ready to move on or retire,” explains Hugues Boisvert, a business lawyer and CEO of HazloLaw Business Lawyers in Ottawa, Ontario.

So What Is a Capital Gain?

At its most basic, a capital gain is the profit a taxpayer makes by selling property for more than its purchase price (called a “cost base” in tax lingo). In general, when you acquire and subsequently sell something of value, as long as whatever you sold is not inventory and you are not in the business of selling whatever it is that you bought and sold – whether it’s real estate or shares in a corporation or another kind of investment – the resulting increase in value is a capital gain and taxed accordingly. So if you bought a business building for $300,000 and sold it a decade later for $600,000, as long as your occupation isn’t buying and selling buildings, you’d have a capital gain of $300,000, of which only $150,000 is taxable.

Principal Residence

You can have a capital gain if you sell your home, which is your “principal residence” in tax terms. But chances are that the gain on your home is not taxable. Note that if you ever rented out your home, those years aren’t included in the calculation.

Here are some factors that influence capital gains and taxation on the sale of a principal residence:

– You’ll pay income tax on the pro rata portion of the gain corresponding to the rental years if you rented out the residence.

– You get a “bonus” year for your principal residence to bump things up a bit.

– You can only have one principal residence at a time, but you can choose which one of your homes you designate as such.

– If you buy a cottage, and it spikes in value, you can designate it as your principal residence for the years you owned it.

– When you sell your city home, a portion of the resulting gain may be taxable, but the tax savings on your cottage can make up for it and then some.

Even though you may not have to pay any tax, you must report the sale of a principal residence on your income tax return. So when you are doing your taxes, input information about the sale of your home in TurboTax.

Sale of a Business

If you are selling your business, you may be delighted to learn that the payment you receive may be tax-free. Section 110.6 of the Income Tax Act sets out rules that entitle Canadians to a lifetime capital gains deduction of over $800,000 from the sale of the shares of a qualified small business corporation. The operative word here is “qualified” – not every small business qualifies for the deduction, so you may wish to talk to a qualified lawyer before you make plans to sell. Most importantly, you must declare the sale of your shares on your income tax return. Failure to report the gain could result in losing the deduction.

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