In the complicated web of Canadian taxation, the capital gains tax stands out as an important factor, especially for investors and asset holders. It’s also often misunderstood.
If you invest, whether it’s in stocks, funds, precious metals, commodities, or real estate, you are expected to pay capital gains taxes when you sell the asset.
This guide delves into the nuances of the capital gains tax in Canada, focusing on the 50% rule, its implications, and how Canadians can navigate its complexities.
Capital Gains Tax in Canada Explained
The capital gains tax in Canada refers to the tax applied to the profit (or gain) realized from the sale of a capital asset. This could be real estate, stocks, bonds, or other investments.
In Canada, only 50% of the value of any capital gain is subject to tax. This means that if you realize a capital gain of, say, $10,000, only $5,000 of that gain will be counted as taxable income.
Here’s how it works:
- Determine the Adjusted Cost Base (ACB): The ACB is essentially what you originally paid for the asset, plus any additional costs associated with acquiring it (like legal fees, or improvements in the case of property). If you’ve bought shares at different prices, the ACB is the average cost.
- Calculate the Capital Gain: The capital gain is found by subtracting the ACB from the proceeds of disposition (what you sold the asset for):
Capital Gain=Proceeds of Disposition−Adjusted Cost Base - Apply the 50% Inclusion Rate: Only half (50%) of the calculated capital gain is added to your income for the year, and this amount will be taxed at your marginal tax rate.
Common Examples of Capital Gains
- Stocks:
- You buy 100 shares of Company A at $10 per share (total cost: $1,000).
- Later, you sell all these shares for $20 each (total sale: $2,000).
- Your capital gain is: $2,000 (sale) – $1,000 (purchase) = $1,000.
- Taxable capital gain (50% of the capital gain) = $500. This $500 is added to your income for the year and taxed at your marginal rate.
- Real Estate:
- You buy a vacation property for $200,000.
- Over the years, you spend $50,000 in improvements.
- Your ACB is now $250,000.
- Later, you sell the property for $400,000.
- Your capital gain is: $400,000 (sale) – $250,000 (purchase + improvements) = $150,000.
- Taxable capital gain (50% of capital gain)= $75,000. This amount is added to your income for the year and taxed at your marginal rate.
- Collectibles:
- You buy a painting for $5,000.
- You later sell the painting for $15,000.
- Your capital gain is: $15,000 (sale) – $5,000 (purchase) = $10,000.
- Taxable capital gain (50% of capital gain) = $5,000. This amount is added to your income and taxed at your marginal rate.
It’s important to keep records of the purchase and sale of assets, as well as any costs associated with improvements, to accurately determine the capital gains.
There are certain exemptions and special considerations, such as the principal residence exemption in Canada, which may allow homeowners to avoid paying capital gains tax on the sale of their primary residence under specific conditions.
Tax Treatment of Capital Loss
Just as there are tax implications for capital gains in Canada, there are also provisions for capital losses. Understanding how to treat capital losses can help taxpayers offset gains or carry forward losses for future use.
Tax Treatment of Capital Losses in Canada:
- Calculating Capital Loss: Similar to capital gains, capital losses are determined by subtracting the Proceeds of Disposition (what you sold the asset for) from the Adjusted Cost Base (ACB – what you originally paid for the asset, plus any additional costs).
Capital Loss=Adjusted Cost Base−Proceeds of Disposition - Using Capital Losses: Capital losses can be used to offset capital gains in the current year, reducing the taxable capital gain. If your capital losses exceed your capital gains for the year, you’re in a net capital loss position.
- Carrying Losses: If you don’t have any capital gains in the current year to offset with your capital losses, or if you have more capital losses than gains, you can:
- Carry the loss back to any of the three previous years to recover capital gains tax paid in those years.
- Carry the loss forward indefinitely to offset future capital gains.
- Superficial Loss Rule: Be wary of the superficial loss rule. If you sell a property at a loss and buy it back within 30 days (either before or after the sale), the loss is considered a superficial loss and can’t be claimed. This rule also applies if someone closely affiliated with you (like a spouse) makes a similar purchase within the 30-day window.
Examples:
- Stocks:
- You buy 100 shares of Company A at $50 per share (total cost: $5,000).
- Due to market conditions, you later sell these shares for $30 each (total sale: $3,000).
- Your capital loss is: $3,000 (sale) – $5,000 (purchase) = -$2,000.
- If you had a capital gain of $3,000 from another transaction that year, this loss can offset $2,000 of that gain, leaving you with a net taxable capital gain of $1,000.
- Real Estate:
- You buy a plot of land for investment at $150,000.
- Later, you sell the property for $100,000.
- Your capital loss is: $100,000 (sale) – $150,000 (purchase) = -$50,000.
- If you don’t have capital gains in the current year, you can carry this loss backward to the previous three years or forward indefinitely until you can offset it against capital gains.
- Superficial Loss:
- You sell a stock at a loss of $2,000.
- Within 30 days, you buy back the same stock.
- This $2,000 loss is considered a superficial loss, and you can’t claim it. Instead, the loss amount gets added to the ACB of the newly purchased stock.
Carry Capital Loss Forward
The current taxation rules allow you to carry your capital loss forward indefinitely. It means that even if you sustained a capital loss twenty years ago and haven’t used it yet to offset your capital gains tax, you can still use it now. You will have to adjust for the inclusion rate based on the table below:
| Period net capital loss incurred | Inclusion Rate |
|---|---|
| Before May 23, 1985 | 1/2 (50%) |
| After May 22, 1985, and before 1988 | 1/2 (50%) |
| In 1988 and 1989 | 2/3 (66.6666%) |
| From 1990 to 1999 | 3/4 (75%) |
| In 2000 | IR* |
| From 2001 to 2021 | 1/2 (50%) |
How Do I Avoid Capital Gains Tax in Canada?
There are a few ways to avoid or minimize your capital gains tax in Canada:
- Keep eligible assets in tax-sheltered registered accounts, such as Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP).
- Use capital losses from previous years or this year to offset your capital gains fully or partially.
- Employ tax-loss harvesting, i.e., sell poor-performing investment assets to generate a loss that offsets your tax gains.
- Donate your investment assets in kind, i.e., without selling them, to qualified charities.
- Defer the capital gains from the shares of eligible small business corporations.
Capital Gains vs. Business Income
The distinction between capital gains and business income is crucial for tax purposes in Canada. They are treated differently in terms of taxation, and misclassifying one as the other can have significant tax implications. Let’s delve into their differences:
1. Definition:
- Capital Gains: This refers to the profit from selling a capital asset, such as stocks, bonds, real estate, or other investments. Capital gains arise when the selling price of an asset is higher than its purchase price (or adjusted cost base). Only a portion of the capital gain is taxable.
- Business Income: This is the income earned from carrying on a business or trade. It encompasses revenues from sales, services, and other business activities, minus the associated business expenses.
2. Nature of Activity:
- Capital Gains: Typically arise from occasional transactions, often from assets held for the purpose of investment or personal enjoyment rather than from regular business activities.
- Business Income: Arises from regular, frequent, and continuous transactions. If you’re buying and selling assets with high frequency, or if your primary intention is to profit from short-term market fluctuations rather than long-term appreciation, your activities might be deemed business activities.
3. Tax Treatment:
- Capital Gains: In many jurisdictions, including Canada, only a fraction of capital gains is taxable. For instance, in Canada, 50% of capital gains are included in your income for tax purposes.
- Business Income: Generally taxed at regular income tax rates applicable to business earnings. In Canada, this would mean the full amount of net business income is included in taxable income and taxed at your marginal rate.
4. Allowable Deductions:
- Capital Gains: Expenses directly related to the sale or purchase of the asset can be used to adjust the cost base or the disposition proceeds. However, you can’t deduct general expenses like investment advice or interest on money borrowed to invest.
- Business Income: A wider range of deductions is available, encompassing any reasonable expenses incurred to earn business income. This can include wages, rent, advertising costs, and other business-related expenses.
5. Implications of Losses:
- Capital Gains: Capital losses can offset capital gains. If the losses exceed the gains, you may carry them back three years or forward indefinitely in Canada to offset capital gains in those years.
- Business Income: Business losses can be applied against any type of income in the year. Any unused portion can be carried back three years or carried forward up to twenty years.
Examples of where confusion may arise:
- Stock Trading:
- Scenario: Maria buys and holds stocks for long-term appreciation. She sells a few after several years at a profit.
- Likely Classification: Capital gains.
- Scenario: David day-trades stocks, buying and selling multiple times a week based on short-term market fluctuations.
- Likely Classification: Business income.
- Scenario: Maria buys and holds stocks for long-term appreciation. She sells a few after several years at a profit.
- Flipping Real Estate:
- Scenario: James buys a house, lives in it for several years, and then sells it for a profit.
- Likely Classification: Capital gains (though principal residence exemptions may apply in some jurisdictions like Canada).
- Scenario: Karen buys homes, quickly renovates them, and sells them for profit multiple times a year.
- Likely Classification: Business income.
- Scenario: James buys a house, lives in it for several years, and then sells it for a profit.
- Collectibles & Antiques:
- Scenario: Ella buys a painting, keeps it for a decade because she loves the artist, and then sells it at an auction.
- Likely Classification: Capital gains.
- Scenario: Ben frequently buys and sells antiques, hunting for undervalued items at estate sales and then quickly selling them in his store or online.
- Likely Classification: Business income.
- Scenario: Ella buys a painting, keeps it for a decade because she loves the artist, and then sells it at an auction.
- Digital Goods & Domains:
- Scenario: Rachel bought a domain name for a project, but after a few years decided to sell it because someone offered her a good price.
- Likely Classification: Capital gains.
- Scenario: Mike actively hunts for catchy domain names, buys them, and then lists them for sale, selling multiple domains every month.
- Likely Classification: Business income.
- Scenario: Rachel bought a domain name for a project, but after a few years decided to sell it because someone offered her a good price.
Note that the CRA might investigate on a case by case basis, and it will ultimately be up to them to judge whether something is capital gains or business income.
Unique Situations and Exemptions of Capital Gains Tax
Principal Residence Exemption: The principal residence exemption is a significant benefit for homeowners. It allows you to sell your primary residence without incurring capital gains tax on the appreciation in its value.
Small Business Shares: For eligible small business corporations, you might have the opportunity to defer or reduce capital gains tax through specific provisions. This recognizes the importance of supporting small businesses and incentivizes entrepreneurship.
Farm and Fishing Property: The sale of qualified farm or fishing property is subject to unique tax treatment.
FAQs
What Is Superficial Loss in Canada?
If you sell your investment assets at a low price and repurchase them later to generate a capital loss that you can use to offset your capital gains, the CRA might deem it a superficial loss.
It won’t be eligible for offsetting capital gains since it overlaps with tax-loss harvesting. However, there are several differentiating factors, including the time difference between two transactions and the assets you sell to realize a capital loss.
How Long Do You Have to Live in a House to Avoid Capital Gains Tax in Canada?
The CRA doesn’t explicitly specify a timeline about how long you have to live in a house before it’s considered your primary residence and exempted from capital gains tax.
However, if you or your family members have inhabited a property for some time of the year, and it’s not your business to buy properties, live there for a time, and sell them for a profit, you might be able to avoid capital gains tax.
Conclusion
Capital gains tax is one of the reasons why you’re always encouraged to fill your tax-sheltered accounts to the brim before looking into investment assets that can’t be placed in registered accounts. But there is no need to sacrifice profits or gains for fear of taxes.
Understanding capital gains tax in Canada is significant for real estate investors to figure out ways of maximizing their returns from their investment properties.
It’s important to note that the advice and examples stated above are written from the perspective of a broader audience, so if you have any specific tax-related questions, make sure to contact a CPA.
Do these rules apply to businesses that invest in shares?
Hi,
My wife and i are planing to retire in asia and live there full time. We have bought precious metals over the years as our “nest egg” and we have them stored in a secure storage facility in canada that specializes in that sort of thing. The company that stores our precious metals also has a service for selling them and depositing the proceeds into our overseas bank (non-canadian) when needed. However, they have said that they are required to report the sale of the metals to the canadian government for capital gains purposes. My question is: if we are non-residents and the sale of the precious metals in made in canada and the proceeds sent overseas, will those sales still be subject to capital gains tax in canada? Thank you for any information you can provide.
I’m going to guess yes they would be subject to taxes, but for complicated tax scenarios like this I would definitely call an accountant. You might have some special circumstances that they could help with.
Hello! I helped my daughter buy a condo from an inheritance. She and I co-own it. From reading your article, if sold, I need to provide the purchase price and associated legal and transaction fees then subtract the selling price to get a capital gain number. It should only be half of the profit since we are co-owners correct? And then only half of that taxed? The condo is her primary residence but secondary for me.
Example: Purchase price plus expenses $400,000. Selling price $500,000. Taxation is on 50% (co-owned) of 50% of the $100,000 gain = $25,000 added to income.
Is that correct??
To be honest I am not sure how it works if you are co-owners. You should probably talk to an accountant for this one. There might be a way you can transfer ownership to her, then she can sell it for no taxes since it’s her primary residence, then can give you the money later. I’m not sure if this is possible or legal though, so consult an accountant as it could save you thousands of dollars.
How do I calculate my capital gains on the sale of my silver maple leafs when I have no purchase records?
I’m not too sure, I’m guessing you’d have to just state the date you got them and use the value of them at that date. But check with an acccountant.
Comprehensive overview Christopher!
During past 3 years I did not file income tax because I was outside Canada and had no income in Canada. Last year I bought first real estate in cash from an my back home savings that came from outside Canada. Now I am unclear how this will impact my tax return and what should be my approach to tax return. Would I be questioned by CRA, what I should expect and what are your expert recommendations? Thanks Christopher
It’s possible you could be questioned by the CRA, but if you were a non resident of Canada the last few years you might be ok. You’d have to consult a tax expert to be sure.
I have a question about including expenses in the calculation. I have a friend with a property in Phoenix that they bought in 2008, Sold in 2021. Every maintenance they have done since purchase they have on a spread sheet and have the receipts. Can they claim all those expenses, thereby reducing their capital gain? What is a reasonable time frame to claim maintenance expenses?
According to this CRA info doc you should be ok, but if you’re unsure I would either call them or check with your accountant: https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/rental-income/completing-form-t776-statement-real-estate-rentals/rental-expenses-you-deduct.html#Maintenanceandrepairs
Great overview Christopher. We unfortunately discovered that the acreage surrounding our primary residence in Ontario is not eligible for capital gains exemption and instead any profit upon eventual disposition / transfer to our kids will be treated as investment income. Makes it very hard for rural Canadians to pass on the family homestead, or for that matter sell and buy a retirement home closer to city amenities.. Especially given rural residences have only appreciated in value over past decades at a fraction the percent of city homes. For rural dwellers, CRA only allows the exemption for the residence itself and up to 1.25 acres of land it sits on. There is a possible exemption for active farmland but only if the owners generate the majority of their income farming it themselves in the proceeding last few years…..often not the case with elderly farm owners who are winding down.
Wow that’s terrible to hear! I’m sorry that you had to go through that. It’s useful information for my other readers to have, thank you for your comment. I wasn’t aware of the rule for rural property, yes it does seem unfair to punish rural property owners vs city.