Canadian tax laws have a lot of nuances and specifics — one of which is capital gains tax. This type of tax arises when you purchase property and sell it later for a profit or loss. If you sold property during the year, you might be hit with an unexpected bill during tax season. Continue reading to learn more about how capital gains tax works in Canada.
Table of contents
- What are capital gains?
- What are capital losses?
- How are capital gains calculated?
- How to avoid capital gains tax in Canada
- Are dividends considered capital gains?
- Claiming a Capital Gains Reserve
- What is are the ‘superficial loss’ rules?
- Capital Gains Tax in Canada
What are capital gains?
Investing can yield a very healthy income. But, along with that generated income comes capital gains tax.
What are capital gains? According to Investopedia, a capital gain is “an increase in a capital asset’s value and is considered to be realized when the asset is sold.”
The Canada Revenue Agency (CRA) charges a tax on any asset or investment that you sell for a profit. When charged with capital gains, a percentage of the difference between the purchase and sale price is added to the income you made. Capital gains taxes are most commonly associated with real estate, however, they are also charged with a wide variety of investments and the resulting income. For instance, stock sales outside of tax-sheltered accounts, sale of art or even the sale of a recreational vehicle.
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What are capital losses?
While capital gains represent income generated from an investment, capital losses are the difference between the lower selling price and the original higher purchase price. As Investopedia explains, a capital loss is “a loss incurred when a capital asset is sold for less than the price it was purchased for.”
At tax time, you can use capital losses against any capital gains to reduce your taxable income for that tax year. Capital losses can be applied backwards three years or forwards indefinitely. Furthermore, capital losses can only be applied against capital gains. They cannot be applied against other types of income.
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How are capital gains calculated?
The capital gains tax is the same for everyone in Canada — currently 50% of the capital gain or loss. For example, if you buy a stock at $100, and it sells for $150, the total capital gain amount is $50 ($150 – $100). However, only 50% is taxable which equates to $25 (50% x $50). You would pay your marginal tax rate on the $25 taxable capital gain. Seems pretty simple right? Let’s take a look at a more complex example below that includes both a capital gain and loss.
In 2012, Laurie purchased a piece of art at a crafts show for $500. In 2022, she sells it for a profit of $2,500. Laurie is passionate about investing so she also has an abundant stock portfolio. In 2019, she purchased some stock for $1,000. Unfortunately, the stocks lost a lot of their value and Laurie decided to cut her losses in 2022. She sold her stock for $250. Her net taxable capital gain is calculated as follows:
|Art Purchase Price||$500|
|Art Sale Price||$2,500|
|Capital Gain ($2,500 – $500)||$2,000|
|Taxable Capital Gain ($2,000 x 50%)||$1,000|
|Stock Purchase Price||$1,000|
|Stock Sale Price||$250|
|Capital Loss ($250 – $1,000)||$750|
|Taxable Capital Loss ($750 x 50%)||$375|
|Net Taxable Capital Gain ($1,000 – $375)||$625|
Laurie would have to pay tax on $625 in capital gains for the 2022 year.
Need more help with your capital gains calculations? A capital gains calculator can help you figure it out.
How to avoid capital gains tax in Canada
Capital gains tax applies to all income generated from investments. However, there is a way to mitigate or reduce the amount you pay.
Dividing up the sale of your assets has a significant impact on capital gains owing. If you plan on selling a number of properties or investments, stagger the sales between multiple years to smooth the tax burden. This way, you aren’t paying an absurd amount of tax in one year, then next to nothing in another year.
If your income varies year-over-year, it is also possible to offset a capital gains claim until a year where you make less money. By doing this, you face lower taxes and keep more of the capital gains earned from selling your investment.
If you want to hold onto the assets of the investment, consider gifting the asset to an organization or a person. Keep in mind, though, these aren’t equally appealing.
If you gift stock as a donation, you’ll get a tax receipt and avoid the capital gains tax in Canada. And while this is one option, it’s important to note that the actual investment is no longer yours. Gifting it to a family member is also an option, but this functions more like tax deferral to someone else, instead of actual tax avoidance.
Optimize tax-sheltered accounts
Tax-Free Savings Accounts (TFSAs), Registered Retirement Savings Plans (RRSPs) and other similar tax-sheltered accounts allow you to invest without paying tax on investment income. Try to utilize these accounts as much as possible to avoid capital gains tax. Unfortunately, tax-sheltered accounts don’t allow you to buy and sell certain kinds of investments, such as art, recreational vehicles and so on.
Lifetime Capital Gains Exemption (LCGE)
If you are a business owner in Canada or operate a farm or a fishery, you can benefit from the Lifetime Capital Gains Exemption. The amount of the exemption changes annually, however, it is currently close to $1 million. Canadian business owners can only use the LCGE when they sell a business through a share sale. In addition, they must meet some other specific criteria. But this exemption is meant to reduce tax when selling a business which are quite large transactions usually resulting in a gain.
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Are dividends considered capital gains?
Investing in dividend stocks means benefiting from a payout a few times a year. Dividends are considered investment income, but not capital gains. Rather, dividends are a profit share paid to stockholders as a reward for their investment in the company. For this reason, it’s not fair to say it’s a capital gain because you didn’t sell the stock to earn a dividend. Instead, dividends are grossed up and included as income on your tax return. Then, you’re eligible for a dividend tax credit. However, if you sell the dividend producing stock, then it would be subject to capital gains tax.
Claiming a Capital Gains Reserve
Not all purchases are paid for in full on the sale of an asset. There are instances where you pay out a portion of a sale in year one. Then, you pay off the remainder over a number of years. Often, this is a component of a large sale to ease the cash flow of the transaction. In these cases, the CRA may allow a Capital Gains Reserve claim. With this option, you claim the portion of the sale paid in that year, rather than the entirety of the sale price at once.
What is are the ‘superficial loss’ rules?
Superficial loss rules are for situations where someone tries circumventing capital gains tax by selling an asset, claiming a loss, and then buying it back right away. To clarify, the CRA created it to deal with anyone trying to cheat the system or evade tax. The rule states that, if you sell and repurchase the exact same investment within 30 days, you can’t claim a capital loss on your tax return.
These rules also apply if you sell a property, for example, and a family member purchases the exact same property from you within those 30 days.
Tips for Managing the Superficial Loss Rules
Savvy investors have a workaround to avoid the ding of the superficial loss rule. Let’s say you invest in an asset that tracks the S&P 500 index. Simply sell that asset, and find another investment product tracking a similar index.
In addition, consider taking advantage of the opportunity to engage in tax-loss harvesting. This involves offloading underperforming funds, creating a capital loss. Apply this loss to your gain to offset the impact.
You can also mitigate the impact of capital gains tax by donating assets from the gain to charity. When you donate to charity, you receive a tax benefit. And this benefit applies to the gain, reducing the amount owing. Furthermore, the donation is in the form of a transfer of ownership of the stocks, rather than in cash, acting as a portfolio rebalance. This helps mitigate the gains, with the loss of having fewer stocks earning money in your portfolio.
Finally, you always have the option of holding off on reporting the loss until next year’s taxes. This method of reducing capital gains is a bit more tricky. The government requires that you report both gains and losses if you incur both in the same tax year. If, however, you only incur losses, carry them over until such time (within the next three years) that you have gains to help offset the loss.
Related Reading: How Estate and Inheritance Taxes Work in Canada
Capital Gains Tax in Canada
There are a few certainties in life: death and taxes — including capital gains tax on the sale of an asset. In other countries, there may be some tips and tricks and loopholes to mitigate the hit. But in Canada, if you make money off of an asset, you pay capital gains tax on it. Your best bet? Talking to a financial professional to help you legally, and effectively mitigate the impact of capital gains.
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