How To Avoid The Capital Gains Tax

When you make savvy investments, the potential benefits can be rewarding, especially if you can cash out at a profit someday. That said, depending on what you’re investing in, it can take a lot of time, stress, and extra money before you’ll see any of that profit. Real estate, for instance, is where a lot of investors experience this problem.

Not to mention, if you do manage to sell or increase the value of your investment, you could be subject to the capital gains tax. 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?

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

Occur when the value of your investment goes up. 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 for tax purposes. 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.

Capital Losses

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 rectify past tax bills, or you can use them to counteract your capital gains for years 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 extra 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 just apply to homes or other real estate, it may also be standard practice when you sell:

Stocks & bonds
Mutual trust units
Business land, buildings, and equipment
Cottages

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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 allocating funds that you might need in the future. So, if reducing or avoiding the capital gains tax would 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 to offset or amend over the previous 3 years and you’ve only experienced losses as a result. 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 proper gains. 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.

Do A Good Deed To Receive A Deduction

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 charity, you’ll be sent a tax receipt that you can use to deduct a part of that donation from your income taxes. Instead of offering money, you could transfer ownership of the investment to the organization you’re supporting. 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, which you must do if you have gains and losses within the same tax year. 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. If you continue buying and selling low-performing investments during the year, you may even be able to get your taxable income to zero.

Watch Out For The Superficial Loss Rule

If you plan on buying and selling stocks or property in order to purposely incur a capital loss, you may not be allowed to use it to reduce your capital gains tax. That is 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). You can also withdraw money from it whenever you want, tax-free, and allow contributions to carry over for years to come.

The same goes for other tax-advantaged accounts, such as your Registered Retired Savings Plan (RRSP), which also allows for tax-free withdrawals and deposits. 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.

Everything you need to know about the GST/HST tax credit.

How Do You Calculate Capital Gains Tax?

To calculate your capital gains tax, you’ll have to start by tallying up your investment’s “Adjusted Cost Base” (ACB), meaning how much you originally paid for it (also known as its book value), plus any fees, interest, or other costs it’s 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 whether you would be making or losing money when you sell the investment, which you can do by calculating 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.

Additional Reading

Frequently Asked Questions

Can my home be exempted from the capital gains tax?

If you purchase a house and use it as your primary residence, you may be exempt from the capital gains tax when you sell it someday. The same principle applies to a farm, fishing property, or other small business that you sell up to a $1,000,000 lifetime limit. Otherwise known as the Lifetime Capital Gains Exemption (LCGE), simply fill out Line 145 on your income tax return in order to qualify.

What is the capital gains tax rate in Canada?

The rate at which your capital gains will be taxed is dependant on your overall taxable income. That’s because, the capital gains you earn is added to your taxable income, which may change the tax bracket you fall under. The higher your taxable income the higher the tax rate you’ll be taxed at. However, do remember, that only 50% of your capital gains is taxable.

Looking To Lower Your Yearly Tax Bill?

If you’ve purchased a home or made some other kind of investment, the capital gains tax you must pay when you sell it can significantly increase the size of your final tax bill, especially if you don’t use your 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.

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Bryan Daly

Bryan is a graduate of Dawson College and Concordia University. He has been writing for Loans Canada for five years, covering all things related to personal finance, and aims to pursue the craft of professional writing for many years to come. In his spare time, he maintains a passion for editing, writing screenplays, staying fit, and traveling the world in search of the coolest sights our planet has to offer. Bryan uses the BMO Cash Back Mastercard to earn cash back on everything from boring bill payments to exciting excursions. He is also a strong saver, holding both a TFSA and an RRSP account in order to prepare for his future while taking full advantage of tax benefits.