Capital Gains in Canada – Here is What You Need to Know

Capital Gains Tax (CGT) is a tax on the profit realized on the sale of a non-inventory asset that was greater in value than the purchase price.  Simply put – did your asset increase in value between when you acquired it and when you sold it?

In Canada, this tax is a significant consideration for investors and individuals who sell assets such as stocks, bonds, real estate, digital assets, and even certain personal properties.

How is Capital Gains Tax Calculated?

In Canada, the calculation of capital gains tax involves several steps:

1. Determine the Capital Gain or Loss: This is the difference between the selling price of the asset and its original purchase price (also known as the adjusted cost base).  Costs associated with the purchase and sale (like legal fees and commissions) can be included in the calculation.
2. Include the Inclusion Rate: Currently, only 50% of the calculated capital gain is taxable.  This is known as the inclusion rate.  For example, if you make a capital gain of $100,000, only $50,000 of that gain is included as taxable income.  It should be noted that, at the time of writing, the Canadian government is considering raising this tax on high-income earners.
3. Apply the Marginal Tax Rate: The taxable portion of the capital gain is then subject to your marginal tax rate, which varies depending on your total income and province of residence.

Historical Context and Rationale

The capital gains tax was introduced in Canada in 1972 as part of a broader tax reform effort aimed at improving the tax system’s fairness.  Before 1972, income from capital gains was not taxed, which favored wealthy individuals who could earn much of their income from investments.  The tax was implemented to ensure that profits from investments were taxed similarly to wages and salaries.

Key Aspects Investors Need to Know

While you may not be able to escape paying a CGT on your investments, there are various approaches that can either provide an exemption or at least ease the associated tax burden.  These include, but are not limited to the following.

• Principal Residence Exemption: One of the most significant exemptions to the capital gains tax in Canada is the principal residence exemption.  If you sell your primary home, you may not have to pay capital gains tax on the profit.
• Lifetime Capital Gains Exemption (LCGE): There is a lifetime exemption limit for certain types of assets, such as qualified small business corporation shares or qualified farm or fishing property (as of 2021, up to $892,218 for small business shares).
• Tax Loss Harvesting: Investors can use capital losses to offset capital gains.  If your capital losses exceed your capital gains, you can carry the excess amount back three years or forward indefinitely to offset gains in other years.
• Timing of Sales: The timing of an asset’s sale can significantly impact the tax owed.  Planning sales to coincide with years of lower overall income can reduce the amount of tax paid on capital gains.

Conclusion

The Capital Gains Tax is a critical consideration for Canadian investors.  Understanding how it works, the associated exemptions and strategic planning around asset sales can significantly impact an investor’s after-tax income.

Whether you’re selling personal property, stocks, or real estate, it’s essential to consider the implications of capital gains tax and plan accordingly.  Investors are advised to consult with tax professionals to navigate complex situations and optimize their tax outcomes.

Choose a Stock Broker

Now that you have a better understanding of what the CGT entails, you are one step further along your investment journey.  Now, take the time to research and choose a reputable broker that can help you take the next one.  Our top recommendations for stock brokers serving Canada can be found HERE.