Investments are a proven way to increase your wealth not just because of big returns on your money. It is also because of how the capital gains tax lets you keep more of your profits. Not only does the capital gains tax help you keep more of your profits, there are ways to reduce how much you owe.
If you’d like to know what types of investments this tax applies to and how you can avoid it, check out the information below.
What Is Capital Gains Tax in Canada?
To figure out what this tax applies to and how to calculate it, it’s essential to understand what capital gains and losses are:
Capital gains happen when the value of your investment goes up and you sell at a profit. If you sell the investment at a profit, the money you make will qualify as “realized gain” and you must declare it to the Canada Revenue Agency (CRA).
However, in Canada, only 50% of your gains are taxable, so you only have to add 50% of your gains to your income taxes. However, if you don’t sell, the gains will stay “unrealized” and you won’t have to pay taxes on them.
The amount of tax you end up paying when you sell depends on how much income you make and where it’s coming from.
These happen when you lose money on an investment, whether before or after it’s been sold. Luckily, your losses can be carried back 3 years to pay past tax debt. You can also use them to lower your capital gains taxes foryears to come, so you won’t have to pay as much during tax season.
At the moment, there is no set limit for how long you can use your losses to offset your gains, so be sure to keep your tax records until this rule changes. Even if you haven’t made any capital gains, you still have to report your losses to the CRA.
What Is Canada’s Capital Gains Tax Rate?
In reality, the capital gains tax doesn’t apply directly to your capital gains, but rather to the passive income you’re making from them. In Canada, up to 50% of the value of your capital gains may be subject to tax. This is known as the incursion rate.
So, if you manage to sell your investment at a profit, 50% of the additional money you earn must be added to your regular taxable income. The more valuable your capital gains are when you sell, the more you’ll pay overall when you file your income taxes.
Does The Capital Gains Tax Only Apply To Homes?
No, the capital gains tax doesn’t apply when you sell your primary residence. It just applies to other real estate you sell. It also applies when you sell:
- Stocks & bonds
- Mutual trust units
- Business land, buildings, and equipment
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Are There Ways To Avoid The Capital Gains Tax?
Before you invest in anything, consider how much said investment could cost you in the long run. After all, you’re locking up funds that you might need in the future.
So, if reducing or avoiding the capital gains tax can help save you money, it’s best to try. Luckily, there are a few ways that you can do that, including but not limited to:
Carry Your Losses Over To The Next Year
It’s possible that you haven’t made any capital gains in the previous 3 years and you’ve only experienced losses. In that case, it may be better to hold off on selling your asset or investment until the next tax year, when you’ve had a chance to make some profit.
You can use your previous year’s losses to offset your future capital gains. Just make sure you’re not continually losing money unless you’re gaining it back in some capacity. Losing money all the time is not the goal of investing.
Reduce Your Capital Gains Tax With A Donation Receipt
Another way to minimize the capital gains tax is by donating assets, such as stocks or properties, to a worthy cause. For instance, if you donate to a registered charity, you’ll be sent a tax receipt that you can use to deduct a part of that donation from your income taxes.
However, instead of offering money, you can transfer ownership of the investment to the organization. Because you’re not actually selling the asset, you can use your receipt to receive the same kind of tax offset, without it qualifying as a capital gain. You can also achieve this by transferring it to a friend or family member.
Harvest Your Tax Losses
As mentioned, one of the most common ways to reduce your taxable income and even be exempt from the capital gains tax is to use your losses to offset your gains. You do this if you have gains and losses within the same tax year. à
In fact, some people buy low-performing investments specifically for this purpose.
For example: if you made $30,000 in capital gains throughout the year, but lost $15,000, you could deduct that loss, then divide the remaining $15,000 by 50%, leaving you with only $7,500 in taxable income.
$30,000 * 50% = $15,000
$15,000 * 50% = $7,500 – this is the taxable income.
If you continue buying and selling low-performing investments during the year, you may even be able to get your taxable income to zero.
Warning: Watch Out For The Superficial Loss Rule
However, the CRA is aware that some people plan to buy and sell stocks or property in order to purposely incur a capital loss. That is why you may not be allowed to use it to reduce your capital gains tax if you, or a person affiliated with you, buys back the property (or similar property) or stock within 30 days of selling the original asset.
Use A TFSA Or RRSP Account
In Canada, there are a few different tax-sheltered accounts that you can open through your bank or other financial institution. For instance, you can continually make deposits to a tax-free savings account (TFSA) and won’t have to declare any interest it generates (up until a specific limit).
This way you can also withdraw money from it whenever you want, tax-free, and allow contributions to carry over for years to come.
In this case, however, you’ll have to avoid withdrawing the funds to benefit from any contributions or tax-free growth, at least until you’ve retired. You’ll only have to pay income tax on the account when that day comes.
How Do You Calculate Capital Gains Tax in Canada?
To calculate your capital gains tax, you’ll have to start by calculating your investment’s “Adjusted Cost Base” (ACB). The ACB is how much you originally paid for the investment, also known as its book value, plus any fees, interest, or other costs incurred by the time you sell.
Don’t worry, if you’re not sure how much you’ve invested. Your financial institution can calculate the full sum for you, unless you have a self-directed account.
- Taxable Income = Selling Price of Investment – Adjusted Cost Base
To determine how much of your new income will be subject to the capital gains tax, you simply have to subtract your ACB from the amount that you sold the investment for.
Watch out, you may have a few different ACBs if you purchase shares of a company or real estate properties with different book values.
Example #1 – Adjusted Cost Base
To figure out how much you’ll pay for your capital gains, you’ll have to determine if you would make or lose money when you sell the investment. You just have to calculate your Adjusted Cost Base. Here’s a standard example of what that cost would be if you purchase real estate:
- You buy a house that initially costs $350,000
- You also paid $5,000 in taxes and fees when you purchased the property
- Then you sunk $30,000 worth of repairs, additions, or renovations into it
- $350,000 + $5,000 + $30,000 = $385,000 is your ACB
Example #2 – Capital Gain
Here’s an example of what could happen if you sell the home at a profit:
- You sell the property for $450,000 ($100,000 more than the original price)
- Then subtract your total ACB ($450,000 – $385,000 = $65,000 in capital gain)
- Apply Canada’s 50% incursion rate ($65,000/2 = $32,500 of taxable income)
- Fill out the proper forms to transfer this portion of your gain to your total income
- The CRA will then tax this additional income and you can keep the rest, tax-free
- The total taxes you pay depend on how much income your other sources provide
Example #2 – Capital Loss
If you lose money on the home, here’s what could happen:
- You purchased the property for the same $350,000 price tag
- The ACB is still $385,000 when you factor in all other initial costs
- Unfortunately, you’re only able to sell the home for $300,000
- This leaves you with a capital loss of -$85,000
- You can now report this loss to the CRA, which can lower your taxable income
- While you won’t be eligible for the same benefits, you may pay fewer taxes overall
Check out which receipts you should keep when filing your taxes.
Use The Capital Gains Tax in Canada to Lower Your Yearly Tax Bill
If you’ve purchased a second home, investment property, or another kind of investment, you pay a capital gains tax when you sell it . This can significantly increase the size of your final tax bill, especially if you don’t use any other eligible losses to offset your gains. As such, it’s important to learn which investments are the safest and when the right time to sell them is.