How Are Capital Gains Taxed in Canada?

Video Script

In this video, I’m going to go over how capital gains are taxed in Canada and how you can use capital losses to prevent excess taxation.

I’ll cover the top 5 things you need to know about how capital gains work in Canada.

Stay till the end to find out seven ways you can minimize the tax you pay on capital gains.

I’m John Woodfield, a portfolio manager and financial advisor for over thirty years. I speak to clients every day, and concerns about taxation and capital gains come up frequently.

So let’s get into it!

First, what are capital gains?

You sell your home in Canada for more than you originally paid, and just like that, you’ve made a capital gain.

We’ll get into how you can calculate your capital gains in a moment.

But what are capital losses?

Capital losses are the financial losses you encounter when you sell an asset, like stocks or real estate, for less than what you originally paid for it.

Let’s say you buy a fixer-upper condo in an up-and-coming area, thinking you’re going to see the next big real estate boom. But then you end up selling it for less than you bought it plus the renovation costs - that's a capital loss.

These losses aren’t all doom and gloom, though; you can often use them to offset capital gains, which can reduce the amount of taxes you owe.

But how are capital gains taxed in Canada?

In Canada, capital gains are the proceeds from the sale, less the adjusted cost base. But what does that really mean in practice?

Say you sell a rental property.

To calculate your capital gains, you start by taking the amount you sold it for and then subtracting the cost of the sale and what you initially paid for it, plus any associated costs.

As of this filming, Canada taxes you on only 50% of the capital gain.

So, in this example, if you bought the property for $30,000, sell the property for $100,000 and have $5,000 in sale costs, your capital gain would be $65,000.

If that property is eligible to be designated as your primary residence for every year of ownership, you wouldn’t have to pay tax on the capital gains. But since it’s a rental property and not your home, you’ll have to figure out how much tax you owe on these capital gains.

Since you’re only taxed on 50% of the capital gains, you’ll be taxed on $32,500 rather than the full $65,000.

This amount gets added to your other income for the year and is taxed at your marginal tax rate.

Let’s shift gears and talk about what happens when you face a capital loss.

Imagine you bought shares in Google that you were planning on holding on to for a while. But then there’s a family emergency and you need the capital that’s tied up in the stock. Unfortunately the price of Google hasn’t gone up.

You initially paid $300,000 for the shares. However, you ended up selling them for $250,000.

The math here shows a capital loss of $50,000.

The silver lining is that you can use half of this loss, which is $25,000, to offset your taxable capital gains.

Now, you can't directly subtract this capital loss from your regular income in the year you made the sale, but you can use it like a wild card to offset capital gains in the past three years or any future taxable year.

And, there's a special twist - in the year of death, and the year prior to death, you can actually use this capital loss against any type of income after first applying it against capital gains. It's like a parting gift from the tax world.

Now, let’s talk about those magical moments when you can avoid the capital gains tax in Canada.

First up is the Principal Residence Exemption (PRE). This is like a golden ticket for homeowners.

Essentially, if you are a Canadian tax resident selling your principal residence and it is eligible for the principal residence exemption for all years, you won’t have to pay capital gains tax on any profit you make.

You even get some flexibility if you sell and buy another home within the same year.

This is a one-plus formula which shelters gains when you sell one residence and purchase another within the same year.

To calculate this, you multiply the capital gain on the sale by the number of years you’ve designated it as your principal residence plus 1, and then divide by the number of years you’ve owned it.

Let’s imagine you purchased a cottage property that you never rented.

You bought the property for $30,000, sold for $100,000 and have $5,000 in sale costs, so your capital gain would be $65,000.

However, you want to claim the PRE on the qualifying home for 2 out of the 5 years that you owned it and occupied it. With the one-plus formula, you’ll take the $65,000 in capital gains, multiply by 2+1, and then divide by 5.

$65,000 x 3 is $195,000. Divide by the number of years owned, and you get $39,000.

Thus your tax exemption is $39,000. You now only have to include $26,000 of the capital gains as income. And since you’re only taxed on half of your capital gains, you’ll pay tax on just $13,000.

If you’re in a high tax bracket, you may pay 53.50% on those gains in British Columbia, which is $6,955.

But that’s a considerable tax saving, compared to if you hadn’t claimed the PRE on the qualifying property, in which case you’d pay $17,388 in tax, if you were in the highest tax bracket.

When more than one property qualifies for the PRE in a particular year, the property with the greatest gain per year should be selected.

Many people don’t realize the requirement for the property to be qualified for the PRE is somewhat flexible.

A house has to be “ordinarily inhabited” to qualify for the PRE.

However, the term “ordinarily inhabited” is generously interpreted by CRA.

For example, vacation properties or other properties that are used seasonally may qualify. However, the taxpayer should be able to prove that he or she went there regularly.

There are also situations which may trigger what is called a deemed disposition.

A deemed disposition is when a taxpayer's property, such as a home or investments, is treated as if it were sold, regardless of whether it is actually sold or not.

This would result in capital gains. We go into this in more detail on our blog. You can find the link to the capital gains blog in the description box.

Before we talk about how to AVOID or REDUCE capital gains tax in Canada, make sure you subscribe and like this video to get more videos from us about Canadian financial planning, investing and cross-border wealth.

OK, so how can you avoid or reduce capital gains tax in Canada?

While you cannot avoid "death and taxes," you can reduce your taxes by using a few different planning strategies that help to minimize capital gains tax.

There are seven main things people commonly do to reduce capital gains tax in Canada.

We’ve covered three of them already.

We’ve talked about using capital losses to offset capital gains, using the Principal Residence Exemption, and carrying forward capital losses into future years or carrying them back up to three years.

Now here are four more ways that you can reduce capital gains tax in Canada:

1) You could shelter tax and capital gains by funding an RRSP, TFSA and RESP in Canada. Each one has various funding rules and requirements but is a great way to save money and taxes.

2) You could donate shares to a charity in kind. Rather than cashing out the shares, you would donate them in their original form to eliminate the capital gain.

3) You may be able to take advantage of the Lifetime Capital Gains Exemption (LCGE) if you sell qualifying property such as shares of a small business corporation and certain interests in farming or fishing properties.

4) When transferring property or a business to a family, you might be able to spread the capital gains over a few years to take advantage of progressive tax rates. There are rules you must follow to do this, so you should do more research on it or speak to an accountant.

Just because you made money, doesn’t mean you should have to give it all away.

Tax planning is an important part of financial planning, so make sure you consider the tax implications of buying and selling your investments.

Finally, if you’re planning on moving from the U.S. to Canada, or you’re living in Canada and need help with your investment portfolio, I recommend you schedule a call with a SWAN Wealth advisor.