All that you want to know about Capital Gains in Canada

To read more chapters, click below:

Chapter 2: Effect of capital gains on property and investments

Chapter 3: Realized vs. unrealized capital gains

Chapter 4: Capital Gains on Primary Residence and Principal Residence Exemption

Most people, who don’t have a finance background, the terms like capital gains and capital losses seem to be a rather technical jargon for them. But fret not! We are here to simplify these terms for you.

Simply, Capital gain is the gain you get when you sell your capital asset. But, What is a Capital Asset? Capital asset refers to assets or items that you possess primarily for the purpose of investment. These assets can include various things such as stocks (shares in various companies), real estate properties, or valuable items like artwork.

Now, "Gains" and "losses" refer to the financial outcomes that you experience when you decide to sell these capital assets.

Gains occur when you sell your asset for a higher price than what you initially paid for it. In other words, it's the profit you make from the sale. For example, you purchased a share in a company for $100, and after a few years, you sell that share and the net amount you received after deducting brokerage charges etc. is $250. So, your capital gain would be $ 150 (250-100).

Losses, on the other hand, happen when you sell your capital asset for less than its original purchase price. So in the above example, if the net amount you received from selling the share is $80, your capital loss would be $20 (80-100)

Easy, right? But that’s not all, there are a lot more stuff than this, and we will take you through different concepts to help you have a better understanding of Capital Gains.

Things to keep in mind

• When you make money from selling your capital assets for profits, this profit is considered capital gains and is subject to taxation. Yeah, we know this is sad.
• But the good news is, only 50% of your capital gains are taxable and is added to your taxable income. For example, if your capital gain is $150, only $75 would be taxable, and the remaining $75 would not be taxed.
• If you incur losses when selling capital assets, the allowable capital losses can be used to offset the other capital gains. For example, if your capital loss is $20, your allowable capital loss would be $10, which you can set off from other capital gains income. If you do not have capital gain income during the year, you can carry forward the allowable loss of $10.

Capital gains are categorized into two main types –

• Short-Term Capital Gains: These are profits earned from the sale of assets held for one year or less. They are typically taxed at your regular income tax rate.
• Long-Term Capital Gains: These are profits earned from the sale of assets held for more than one year. Long-term capital gains often enjoy preferential tax rates, which are usually lower than regular income tax rates.

How to calculate capital gains tax?

Before you proceed to calculating capital gains tax in Canada, you need to be aware of certain terminologies.

• The Proceeds from Sale: This refers to the amount you will get or have already received from selling the investment.
• The Adjusted Cost Base (ACB): This is the total cost of the investment, including any additional expenses you paid to acquire it, such as commissions and legal fees. For example, you purchased a property for $100,000 and paid $2000 for commission and legal fees, the ACB would be $102,000.
• Outlays and Expenses: These are any expenditures associated with the sale of your capital asset, such as renovation costs, maintenance expenses, as well as commissions and finder's fees.

The formula for computing capital gains incorporates the provided values and is structured as follows –

Proceeds from Sale – (Adjusted Cost Base + Outlays and Expenses) = Capital Gain

If this result is negative, it signifies a capital loss, which can be applied to offset other capital gains in future tax years or for up to three years in the past.

Difference between realized and unrealized capital gain or loss

In Canada, the key difference between realized and unrealized capital gains and losses lies in whether the profit or loss has been actually earned or incurred through the sale of an investment or if it exists only on paper without a sale. To simplify, if you have sold your capital asset, the gain/loss you incurred will be a realized capital gain/loss. However, if you have not sold the capital asset, and merely the value of your capital asset has increased/decreased, it will be an unrealized capital gain/loss.

Realized Capital Gains/Losses-

• Realized capital gains or losses occur when you sell your capital asset and the transaction is completed. It means that you have made a profit (capital gain) or incurred a loss (capital loss) on the investment by selling it.
• 50% of these realized gains are subject to taxation in Canada. You must report them on your income tax return in the year when the sale occurred. The amount you report is the difference between the selling price (proceeds of disposition) and the adjusted cost base (ACB) of the investment, as well as any relevant outlays and expenses.

Unrealized Capital Gains/Losses –

• Unrealized capital gains or losses exist on paper but have not been realized through an actual sale. It means that the value of your investment has gone up (unrealized capital gain) or down (unrealized capital loss) since you acquired it, but you have not sold the investment yet.
• These unrealized gains or losses are not subject to taxation. You do not report them on your income tax return until you sell the investment and realize the gain or loss.

The important distinction between the two is that realized gains and losses are considered taxable events, and you are required to report and potentially pay taxes on them when you file your income tax return. Unrealized gains and losses, on the other hand, are not subject to taxation until the investment is sold.

When do I have to pay capital gains tax?

You are liable for capital gains tax in the tax year when your gains were recognized. For instance, if you sold your stock in 2023, you should report those capital gains as part of your 2023 income.

Capital gains tax rate in Canada!

We know you were wondering; at what rate do I have to pay tax on my realized capital gain. Here you go!

By now, you understand that You are taxed on only 50% of your capital gains, and the other half remains tax-free. For example, if you made a profit of $5,000 from selling stocks, you'll be taxed on half of that amount, which is $2,500.

It's important to clarify that this doesn't mean you have to immediately send the taxable $2,500 to the government. This is a common misconception. Instead, you pay a portion of that amount, similar to how you pay a percentage of your total income from your paycheck, even though you earn $2,500 in total income. This taxable capital gain of $2500 would be added to your normal income and thus will be taxed just like your normal income.

How does capital gains tax work in Canada?

We would like to reiterate that you're only liable for taxes on realized capital gains. This means that even if you believe the value of your capital asset has increased compared to what you paid for it, you won't incur taxes until the land is sold, and you receive the capital gains.

It is also important to remember that you're taxed solely on the profits generated, not the total sale price.

Last but not the least, certain assets, such as your primary residence, are exempt from capital gains tax, but we will not get into this right now.

How to claim capital losses?

In Canada, you can claim capital losses to offset capital gains for tax purposes. Here's how to do it –

1. Report the Capital Losses on Your Tax Return

When you file your income tax return, you should report your capital losses. You can do this on Schedule 3, which is the Capital Gains (or Losses) form.

2. Calculate Your Net Capital Gain or Loss

On Schedule 3, you'll need to calculate your net capital gain or loss for the year. To do this, add up all your capital gains and losses for the year.

3. Apply the Capital Losses to Offset Capital Gains

If you have a net capital loss for the year (i.e., your capital losses exceed your capital gains), you can use this loss to offset any taxable capital gains you may have realized in the same tax year. This will reduce your overall taxable income.

4. Carry Forward Capital Losses

If your net capital losses for the year exceed your capital gains, you can carry forward the unused portion of the losses to future tax years. In Canada, you can carry forward capital losses indefinitely, allowing you to offset future capital gains. However, it's essential to keep track of these losses over the years.

5. Use Capital Losses from Previous Years

You can also apply capital losses from the previous three years to offset any capital gains in the current year. This is known as carrying back your losses. To do this, you would amend your previous tax returns for those years.

6. Consult a Tax Professional

Tax rules can be complex, and it's advisable to consult a tax professional or accountant, especially if you have significant capital losses or if you want to optimize your tax strategy using capital losses effectively. You can contact us at www.taxccount.com and we would be happy to guide you.

7. Keep Detailed Records

It is important to maintain thorough records of all your capital transactions, including purchase and sale dates, amounts, and associated costs. These records will be essential for accurately calculating and claiming capital losses.

Remember that the specific rules and regulations regarding capital losses can change, so it's essential to stay informed about the most current tax laws and seek professional guidance when necessary to ensure you're maximizing the benefits of your capital losses within the legal framework.

Which capital gains are not taxed in Canada?

There are situations where, even if you make capital gains (i.e., profit from selling assets), you may not be required to pay capital gains tax. These situations include –

1. The sale of your primary residence (with some exceptions, such as if you rented it out or used it for business).
2. Capital gains on stocks if the Canada Revenue Agency (CRA) acknowledges that you earn your income as a day trader.
3. The sale of qualified small business shares and farm and fishing property.

Please note that the CRA defines the last category, "qualified" sales, in a specific way. Not every sale of small business, farm, or fishing property is automatically eligible for an exemption. However, under certain circumstances, it can be exempted from capital gains tax.

When you sell property that qualifies for CRA exemption (e.g., small business, farm, fishing property), the capital gains are not subject to taxation up to a certain limit. This is known as the lifetime capital gains exemption (LCGE). It accumulates, meaning that every sale of this type contributes to the limit. Once you reach this limit, any further sales of this nature will be subject to capital gains tax.

The LCGE limit increases each year. In 2022, it stands at $913,630 for small business shares and $1 million for farms and fishing shares. It's important to clarify that these figures apply to the total capital gains amount, not just the 50% of capital gains that are typically taxable.

Are capital gains different from interest and dividend income?

Earning money through various investment sources, such as interest, dividends, and capital gains, might seem like they should be subject to the same tax rules. However, the Canada Revenue Agency (CRA) distinguishes between these forms of income and treats them differently for taxation purposes.

One crucial term to understand in the context of capital gains is "capital." Capital gains or losses occur when you own a capital asset, and then decide to sell it.

On the other hand, interest and dividends are forms of income that you receive while you still own the underlying asset. These earnings are paid out to you by the issuer of the investment, such as a bond or a stock, as a return on your investment. Since you haven't sold anything, there's no realized gain or loss at this point. Tax-wise, interest and dividends are categorized as investment income.

To sum it up, the crucial distinction lies in the timing and nature of the income. Capital gains and losses come into play when you sell the capital asset you own, whereas interest and dividends are the incomes generated by your ownership of assets. The CRA taxes these types of income differently, with each having its own set of rules and tax treatment. Understanding these distinctions is essential for effective tax planning and investment strategy, and a tax consultant can definitely help you with the same. You can visit us at www.taxccount.com to book a call with us.

How to avoid capital gains tax, legally?

Don’t get too excited, we are not teaching you some tax avoidance techniques. We are just giving you some legal strategies you can adopt to save capital gains tax in Canada-

1. Use tax advantaged accounts

Capital gains typically enjoy the most favorable tax treatment compared to dividends and interest income. Therefore, a wise strategy is to keep investments like stocks, shares, and mutual funds in a non-registered account. In contrast, it's advisable to place higher-taxed assets in a registered vehicle where they can grow without being subject to as much tax.

2. Engage in tax-loss harvesting

In certain situations, you might have the opportunity to diminish your capital gains tax liability by employing a tactic known as "tax loss harvesting." This approach involves selling an investment that has declined in value below its initial purchase price, resulting in a capital loss. You can then apply this capital loss to offset the capital gain generated by another investment, thereby reducing the overall amount you owe in capital gains tax.

3. Donate investments/ assets to charity

When you contribute to a registered charitable organization, you're provided with a tax receipt that allows you to deduct a portion of your donation from your income tax. Instead of donating cash, you have the option to transfer the ownership of stocks to the registered charity, which is known as an "in-kind" transfer. This approach allows you to rebalance your investment portfolio without triggering a capital gain because you're not selling the stock; you're merely changing ownership. You'll receive a tax receipt for the current fair market value of the stocks, reflecting their estimated value on the day of the transaction.

4. Claim a dividend tax credit

Dividends and capital gains are subject to distinct tax treatment. When it comes to dividend income, it's incorporated into your taxable income and involves a gross-up amount of 38% for eligible dividends and 15% for non-eligible dividends. To mitigate the taxes you'll be required to pay on the gross-up amount, you have the option to apply the non-refundable federal dividend tax credit.