What is the Capital Gains Tax?
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.
For example; if someone bought shares for $10,000 and sold them for $15,000, the total capital gain amount would be $5000, and they would pay the marginal tax rate on the $5,000 capital gain. The taxable capital gain would be $2,500 which will be taxed based on the individual’s tax bracket.
If this is your first time dealing with capital gains and are feeling overwhelmed, we have tax experts to help you.
What Are Capital Gains?
When you sell investments or real estate holdings for more than you paid, with a portion of the difference being added to your regular income, you have to declare the additional income as a capital gain. You are then taxed on a percentage (referred to as the inclusion rate) of that gain.
What Is Considered Capital Property?
Capital properties refer to any property or asset, depreciable or otherwise, usually purchased for investment purposes, and that upon its sale would result in a capital gain or loss.
Common types of capital properties include:
- stocks, bonds, units of a mutual fund trust
- land, buildings, or equipment you use for a business
- cottages
How Canada’s Capital Gains Tax works
The capital gains inclusion rate is 50% for all individuals, but the amount of tax you pay depends on your total income, personal situation and your province of residence.
How to Reduce Your Capital Gains Tax
Though the inclusion rate for the capital gains tax is the same for everyone, there are some ways to lower the amount of tax you pay on your capital gains.
- Choose the right time to sell investments.
- Defer the capital gain if you do not expect to receive the money from the sale right away.
- Donate assets to a registered charity or private foundation.
- Those who own a small business, farm, or fishing property can use the Lifetime Capital Gains Exemption (LCGE).
When to Sell Properties and Investments
While you can open registered accounts to shelter investments and use the principal-residence exemption to reduce capital gains tax on residential property, choosing the time of sale for your other investments can be a powerful tax reduction tool.
If you’re planning to sell investments that have made a profit, consider postponing the sale until after January 1st of the next year. You will incur capital gains tax that year and only have to pay by April 30th of the following year.
If your income varies, selling during a year when it is low may save you money. If you have investments that have lost money, selling them in the same year as profitable ones lets you apply the loss against the profits and reduce your overall capital gains tax.
Giving Away Assets
If you make regular charitable donations or want to give money to family members, you can use donations or gifts to reduce your capital gains tax. For example, if you plan to make a $1,000 donation to a charity, you can donate stock which has a value of $1,000 but which originally cost you much less.
Rather than selling the stock, paying capital gains tax and adding cash to make up the $1,000 donation, making the donation in stock entitles you to the $1,000 charitable receipt for tax purposes, while not triggering capital gains tax.
Capital Gain vs. Capital Loss
You have a capital loss when you sell capital property for less than its Adjusted Cost Base, plus any expenses involved in the sale of said property.
Read more on how to calculate your Adjusted Cost Base (ACB)
Gifts to family members trigger capital gains tax, because the CRA deems a gift to be a taxable disposition of an asset. Despite this, you could save money by giving an asset that has generated a loss, but that you want to keep in the family. Gifting the asset produces a capital loss that you can apply to gains from other investments, while your family member reaps the future benefits of it.
Lifetime Capital Gains Exemption
If you own a business or operate a farm or fishing property successfully over an extended period, it may increase in value and you may, at some point, want to sell it. When this is the case, you would incur substantial capital gains tax.
Canadian residents who operate active businesses, farms or fishing properties and whose business is primarily Canadian may reduce their capital gains by the amount of the exemption when they sell these businesses or properties.
The lifetime capital gains exemption which is for small business corporation shares and for qualified fishing and farming properties, is aimed at reducing the amount of this tax.
For example; if in 2020 you sell your business for $2 million and your adjusted cost base representing the amount of capital you have invested is negligible, you have a $2 million capital gain. You deduct your exemption of $$883,384 to get a $1,116,616 taxable capital gain. The inclusion rate is 50%, so you add half of that gain ($558,308) to your total income for the year.
Because businesses have to use at least 90% of their assets in an active business operating primarily in Canada to qualify, consider selling the business at a time when it can fulfill these requirements. To qualify for the farming or fishing property exemption, you must be able to show that farming was your primary source of income or that you operated a fishing business.