Selling your high-performing stocks or your cottage with a view can reap significant profits, and those moments are worth celebrating. But while you’re enjoying the spoils of your investments, keep in mind that you’ll eventually have to pay tax on them. In Canada, most gains on capital assets are taxed. Let’s look at strategies to avoid paying more taxes than you need to come tax time.
A capital gain occurs when you sell an asset or investment at a higher value than its original purchase price, meaning you earn income from the sale. This applies to stocks, bonds and shares in mutual funds and exchange-traded funds (ETFs), as well as rental properties, cottages and business assets and equipment. On the other hand, when you sell an asset for less than its original purchase price, that’s called a capital loss.
Certain types of property are not subject to the rules of capital gains. A home that has served as your principal residence is exempt from capital gains tax—as long as it has been your primary residence for all the years you’ve owned it or for all years except one. (There’s not actually a “capital gains tax,” but more on that below.) The same goes for other forms of personal-use property, such as cars and boats, whose value doesn’t usually increase over the years.
What is the capital gains tax rate in Canada?
Contrary to popular belief, capital gains are not taxed at a set rate of 50%, nor are they taxed in their entirety at your marginal tax rate. Rather, only half (50%) of the capital gain on any given sale is taxed at your marginal tax rate (which varies by province).
On a capital gain of $50,000, for instance, only half of that amount, $25,000, is taxable. And the tax rate depends on your income. For a Canadian who falls in a 33% marginal tax bracket, the income earned from the capital gain of $25,000 results in $8,250 in taxes owing. The remaining $41,750 is the investor’s to keep.
How are capital gains taxed?
To calculate the capital gain or loss on recently sold assets, such as property or stocks, you’ll need the following details, according to the Canada Revenue Agency (CRA):
- Proceeds of disposition: The value of the asset at the time of sale
- Adjusted cost base (ACB): The amount originally paid
- Outlays and expenses: Total of costs deemed necessary before selling, such as renovations and maintenance expenses, finders’ fees, commissions, brokers’ fees, surveyors’ fees, legal fees, transfer taxes and advertising costs
Once you have those three numbers in hand, you can calculate the capital gain by subtracting the ACB and outlays and expenses from the proceeds of disposition.
Proceeds of disposition – (ACB + outlays and expenses) = capital gain
A capital gain is taxed only once it is “realized,” meaning the asset has been sold. As long as the gain is “unrealized,” meaning the asset’s value has increased on paper but the asset remains in your possession, you do not have to pay taxes on it. One strategy to reduce the amount of tax is to time the sale of the asset for a period when your income will be lower—for example, when you’re retired or on leave from work.
If you sell an investment for less than what you paid, you have a capital loss. You don’t pay any tax on capital losses; in fact, they can help offset the taxes you would otherwise pay on capital gains.
How to reduce or avoid capital gains tax in Canada
There are several ways to legally reduce, and in some cases avoid, paying taxes on capital gains.
The first thing to know is that capital gains can be offset with capital losses from other investments, until the balance of capital gains is reduced to zero.
If you have only capital losses in a given year, you can use them to offset gains reported to the CRA during the previous three years. You can also choose to carry those losses into the future—indefinitely—and apply them to another year. The only thing you have to remember is that you can’t claim a capital loss against regular income.
You may want to keep your investments in a registered account, such as a registered retirement savings plan (RRSP), a registered education savings plan (RESP) or a tax-free savings account (TFSA). Investments held in these accounts are tax-sheltered. With RRSPs and RESPs, you’ll pay tax when you withdraw the funds, and TFSA withdrawals are tax-free.
You may also choose to donate securities, such as shares and bonds, by transferring ownership to a registered charity. Taxes on capital gains do not apply to capital transfers to charitable organizations. This allows you to give more than you would with cash—selling the asset first would result in taxes owed—and still receive a charitable tax receipt for the amount donated.
Capital gains on the sale of a property
There are many misconceptions about capital gains tax in Canada, including the belief that all gains are taxed at a rate of 50%. In reality, only half of a realized capital gain—50% of the income you earn from selling an asset—is taxed at your marginal tax rate.
This means the amount you end up paying in tax will depend on the degree to which your asset has grown in value, as well as your other sources of income. And between tax-sheltered investment accounts, the principal residence exemption and the rules around capital losses, there are many legitimate ways to ensure you don’t pay more tax than necessary in any given year.