Mortgage Blog

Understanding Capital Gains in Canada

November 11, 2024 | Posted by: Paul Gazzola

What Are Capital Gains?

Capital gains refer to the profit you earn when you sell a capital asset-such as property or investments-for more than its original purchase price. For example, if you bought stocks for $1,000 and later sold them for $1,500, your capital gain would be $500, excluding any related expenses.

Assets that have increased in value but haven't been sold yet are considered "unrealized" capital gains. These gains become "realized" once the asset is sold, at which point they may be subject to capital gains tax.

Capital Gains Tax Explained

In Canada, capital gains are taxable. The capital gains tax is applied to the profit made from selling a capital asset. If you sell an investment like stocks, mutual funds, or a vacation property at a profit, that gain is subject to this tax.

Conversely, if you sell a capital asset for less than what you paid, you incur a capital loss. This loss can be claimed on your taxes to offset capital gains in the current year, carried forward to future years, or applied to the past three years.

Understanding the Capital Gains Inclusion Rate

The inclusion rate determines the portion of your capital gains that is taxable. As of June 25, 2024, significant changes were made to this rate:

• For capital gains under $250,000: The inclusion rate remains at 50%. This means half of your capital gain is taxable income.
• For capital gains of $250,000 or more: The inclusion rate increases to 66.67%. Therefore, two-thirds of your gain is considered taxable income.

Example: Calculating Taxable Capital Gains

After June 25, 2024: If you sell a vacation property and realize a capital gain of $300,000:

• The first $250,000 is taxed at the 50% inclusion rate:
  • Taxable amount: $250,000 × 50% = $125,000
• The remaining $50,000 is taxed at the 66.67% inclusion rate:
  • Taxable amount: $50,000 × 66.67% ≈ $33,333
• Total taxable capital gain: $125,000 + $33,333 = $158,333
• Amount not taxed: $300,000 - $158,333 = $141,667

Before June 25, 2024: The entire $300,000 gain would be taxed at the 50% inclusion rate:

• Taxable amount: $300,000 × 50% = $150,000
• Amount not taxed: $300,000 - $150,000 = $150,000

Who Is Affected by the Inclusion Rate Change?

The increased inclusion rate primarily affects:

• Corporations and trusts
• Individuals with annual capital gains exceeding $250,000
• High-net-worth individuals
• Those selling high-value assets like investment properties or significant stock portfolios

Your principal residence remains exempt from capital gains tax, provided it meets certain criteria set by the Canada Revenue Agency (CRA).

Standard Capital Gains Tax Rate

Canada does not have a fixed capital gains tax rate. Instead, the taxable portion of your capital gains is added to your income and taxed at your marginal tax rate. This means the amount of tax you pay depends on your total taxable income for the year.

Calculating Your Capital Gains or Losses

To determine your capital gains or losses, you'll need:

1. Adjusted Cost Base (ACB): The original purchase price plus any related costs (e.g., legal fees, commissions, closing costs).
2. Outlays and Expenses: Costs associated with selling the asset (e.g., renovations, transfer taxes, additional legal fees).
3. Proceeds of Disposition: The amount you receive from the sale, minus any selling expenses.

Capital Gain or Loss Calculation:

Strategies to Minimize Capital Gains Tax

1. Invest Through Registered Accounts:

   • Registered Retirement Savings Plans (RRSPs)
   • Tax-Free Savings Accounts (TFSAs)
   • Registered Education Savings Plans (RESPs)
   • First Home Savings Accounts (FHSAs)

   These accounts offer tax advantages, such as tax-deferred growth (RRSPs, RESPs) or tax-free growth and withdrawals (TFSAs).

2. Contribute to RRSPs to Reduce Taxable Income:

   Contributions to RRSPs can lower your taxable income, which may reduce the amount of tax you owe on capital gains.

3. Offset Gains with Capital Losses:

   Use capital losses to offset capital gains. Unused capital losses can be carried forward indefinitely or back three years to reduce taxable gains in other years.

4. Utilize the Principal Residence Exemption:

   To qualify for this exemption:

   • You own the property, alone or with someone else.
   • You designate the property as your principal residence with the CRA.
   • You or your family members inhabit the property.
   • You haven't designated another property as your principal residence during the same period.

5. Estate Planning:

   Upon death, capital assets are deemed to be sold at fair market value, which may result in capital gains tax. Proper estate planning and having a valid will can help minimize taxes and ensure a smooth transfer of assets to your heirs.

Final Thoughts

Understanding how capital gains tax works and staying informed about legislative changes can help you make strategic financial decisions. Consult a tax professional or financial advisor to optimize your tax situation based on your individual circumstances.

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