How do capital gains work?

What are capital gains?

Capital gains are any profit that you make when you dispose of capital assets. Usually that means selling them, but it can also mean any kind of transfer of ownership, such as donating something. Most of the time you have to count this profit as income in your annual tax return.

What are capital assets? Capital assets include cottages, land, business assets or anything you rent no matter how big or small, as well as shares, bonds and mutual funds.

Individuals in Canada must include 50% of the first $250,000 of annual capital gains and 66.67% of any capital gains exceeding $250,000 in their taxable income.

To reduce the tax impact of capital gains, it’s important to understand and work within the rules that govern them. Your accountant can be a good source of information.

How are capital gains on buildings calculated?

It’s relatively simple to calculate the capital gain when you sell a building. It’s the selling price less what you paid for the building, less certain expenses you incurred while you owned it that were aimed at improving the property. These are called capital expenditures.

For example, if you bought a cottage for $200,000 and you sold it for $250,000, your capital gain would be $50,000. However, 50% of this amount is taxable. So you would be taxed on approximately $25,000.

If you gave the cottage to your children instead—the one you purchased for $200,000—and its fair market value (FMV) is estimated at $240,000, you will be considered to have generated a capital gain of $40,000. You will be taxed on this gain, even though you gave the cottage away. If your kids then resell the cottage for $300,000, they’ll also be taxed, on the extra $60,000 in profit.

In fact, only principal residences or transfers between spouses are exempt from capital gains tax. For any other residence, you have to pay tax on the profit you made on the sale.

Are there any capital gain deductions?

Yes, in addition to the initial cost, certain capital expenses may be deductible. This is called the adjusted cost base (ACB). Be sure to keep all your transaction documents (purchase price, aesthetic improvements, clearing, surveying, appraisal, brokerage, etc.).

Some costs related to the sale of your property (commissions, fees, etc.) may also be deductible.

Take the time to properly analyze all these fees when calculating your capital gain and filing your income tax return.

How are capital gains calculated on securities, bonds and mutual funds?

The same rule also generally applies to profits from the sale of securities, such as shares, fixed-income securities, mutual fund units, and so on. 

If the securities are held by an individual, they must include 50% of the first $250,000 of annual capital gains and 66.67% of any capital gains exceeding $250,000 in their taxable income. 

If the securities are held by a corporation or trust, it must include 66.67% of any capital gains generated by the sale of securities in its taxable income. 

In this case, the amount between the purchase price and the sale price will be taxable. Certain interest and financial expenses may also be deductible.

For Canadian businesses with capital dividend accounts (CDA): When corporations with CDAs realize capital gains, the untaxed half of the gain can be added to the CDA in order to pay shareholders a tax-free dividend at a later date. It’s a strategy that can really pay off.

How is capital gain tax calculated?

The tax rate varies depending on the situation and certain criteria, such as the province or territory where you liveand your annual income. The taxable portion of the capital gain is added to all of your other taxable income. Your total income will determine the tax bracket (marginal rate).

Let’s go back to the example of the cottage purchased for $200,000 and sold for $250,000, generating a capital gain of $50,000. You’ll be taxed on approximately $25,000 (50% of the capital gain) according to your tax bracket. (link to external site)

Here are some important things to keep in mind:

• Since capital gains are taxed at 50%, the capital gains tax rate is itself 50% lower. It is often more advantageous than the tax rate on dividends.
• If you realize a taxable capital gain on the sale of a qualifying farm or fishing property, you may be eligible for a capital gain deduction.
• Quebec’s Ministère du Revenu and the Canada Revenue Agency provide detailed documentation on the rules, exceptions and exemptions you can use to optimize your tax strategy.

What are capital losses?

A capital loss is generated when you sell your assets (shares, real estate, etc.) for less than the purchase price.

An individual must deduct 50% of the first $250,000 of capital losses and 66.67% of any capital losses exceeding $250,000 from their taxable income. A corporation or trust must deduct 66.67% of any capital loss from its taxable income.

This can only be used to lower your capital gains. In other words, you cannot deduct this loss directly from your income in order to pay less tax. If you did not realize any capital gains during the year, you can save your capital losses and use them another year. They can be deducted from the capital gains of the previous three years or any future year.

When do capital gains or losses need to be reported?

It’s important to report the capital gain or loss in the calendar year in which you made the transaction, even if you do not have to pay tax.

The capital gain can be either realized or unrealized:

• When you have a capital asset and you make a profit on the sale of your investment, this is a realized capital gain.
• If the value of your capital asset has increased but you haven’t disposed of it yet, then you have an unrealized capital gain.

From a tax perspective, you only have to pay tax on capital gains that have been realized.

How to plan for capital gains

It could save you money to consult a financial advisor, tax specialist, accountant or wealth manager if you are considering generating capital gains or if you have dividend investments.

They may advise you to declare a capital loss or sell securities that have dropped in value to strategically offset gains. Likewise, if your income tends to fluctuate, you could realize your gains in a year your income is lower, to take advantage of a lower tax rate.

The bottom line is that each situation is unique and it’s best to seek expert help to make sure more of your money stays in your pocket.

About to realize a capital gain? We’re here to answer your questions!