Effect of capital gains on property and investments

To read more chapters, click below:

Chapter 1: All that you want to know about Capital Gains in Canada

Chapter 3: Realized vs. unrealized capital gains

Chapter 4: Capital Gains on Primary Residence and Principal Residence Exemption

In the previous chapter we discussed in detail all about capital gains tax in Canada. In this chapter we’ll talk about how capital gains tax and its effect on property and investments in Canada.  It is so crucial to understand that what happens to your investments when you decide to sell them.

Comprehending the concept of capital gains (including losses) and how they influence your income taxes is crucial for making well-informed investment decisions, maximizing your financial returns, and avoiding potentially costly mistakes.

What is capital gains tax on rate on real estate and home sales?

Real estate transactions, including the sale of homes, follow the same capital gains tax principles as any other investment—with one notable exception. If the property you've been living in as your main home and selling has always been your primary residence, you typically won't have to pay capital gains tax. However, if you've ever used any part of your property to make money, you might have to pay capital gains tax on the portion of your property that generated income. This determination depends on factors like how long you used it for income purposes (for example, if you rented it out for a part of the time you owned it) or how much space it took up (like renting out a basement apartment that accounts for a certain percentage of the total living area).

If the property under consideration is subject to capital gains tax, which may be the case for a second home, a cottage, or a piece of land that has generated a profit, there is a specific procedure for taxation. You determine the profit from the sale and then split it in half. This resulting sum is considered as taxable income, much like how your salary, investment returns, and other sources of income are subject to taxation. It's important to clarify a common misunderstanding: you're not required to pay tax on half of the capital gains; rather, you only need to pay tax on half of the capital gains.

This taxation process can be broken down into three straightforward steps –

• Profit Calculation: Determine the total profit obtained from the sale.
• Halving the Profit: Divide the calculated profit in half, which is equivalent to multiplying it by 50%
• Personal Tax Rate Application: Finally, apply your individual tax rate to this halved profit to determine the actual tax amount owed

This approach ensures that you are taxed fairly on your capital gains, considering only half of the profit as taxable income, in accordance with Canadian tax regulations.

Is it possible to incur capital gains tax solely from the sales of the land?

Yes, it is possible to incur capital gains tax solely from the sale of land. In many countries, including Canada, the sale of land can result in capital gains tax liability. The amount of tax owed would depend on several factors, including the following –

• Capital Gain Calculation: The capital gain is typically calculated as the difference between the selling price of the land and its adjusted cost base (ACB). The ACB includes the original purchase price of the land and any eligible costs associated with acquiring and maintaining the property.
• Inclusion Rate: In Canada, as of my last knowledge update in September 2021, only 50% of the capital gain is included in your taxable income. This reduced inclusion rate helps lower the overall tax liability on capital gains.
• Exemptions and Deductions: There may be certain exemptions and deductions available for the sale of land, such as the principal residence exemption or other specific provisions depending on your situation.
• Holding Period: The duration for which you held the land can affect the tax rate you'll pay on any capital gains. In some cases, a longer holding period may lead to lower tax rates.
• Local Regulations: Tax laws and rates can vary by jurisdiction, so it's essential to understand the specific rules and rates that apply in your location.

Imagine this situation: You bought a piece of land on the New Brunswick coast with big dreams of building your ideal home. You invested $100,000 in this beautiful property. However, changing circumstances have made you realize that your dream is no longer possible, and it's time to move on. Luckily, the market is in your favor, and you manage to sell the land for $160,000 – a positive turn of events. The next step involves figuring out your profit. To do this, you need to consider not just the initial property cost but also additional expenses, like real estate agent fees and legal fees, which together make up your Adjusted Cost Base (ACB), as we've defined before. Let's assume these extra costs add up to $10,000. The calculation looks like this:

ACB: $100,000 (land purchase price) + $10,000 (additional costs) = $110,000

Profit: $160,000 (sale proceeds) - $110,000 (ACB) = $50,000

In simple terms, the total capital gains from selling your New Brunswick property now amount to $50,000. Now, for the second step: we know that only half of the capital gains are subject to taxation. So, we take your profit and multiply it by 50%:

$50,000 (profit) x 50% = $25,000

In summary, you'll have an additional $25,000 added to your taxable income for the current calendar year. The specific tax you'll owe depends on your overall taxable income and whether you have any deductions or potential capital losses to offset in that particular tax year.

What is the tax treatment for capital gains from stocks?

When you sell stocks for a higher price than what you initially paid, you realize capital gains, which are subject to taxation. The process for calculating this is similar to how it works for real estate –

• Calculate Your Profit: You start by deducting the cost you initially paid for the stocks (acquisition cost) from the sales proceeds. This gives you your overall profit.
• Determine Taxable Capital Gains: You then take this profit and divide it in half. This halved amount is what's considered as your taxable capital gains.
• Combine with Annual Income: The taxable capital gains are added to your annual personal income. You'll calculate and pay taxes based on the total combined income.

Now, let's illustrate this process with specific numbers using an example.

Suppose you own 100 shares of Big Awesome Company Inc. You bought these shares at an initial cost of $10 each, and when you sold them, you received $15 per share. Additionally, you paid $100 in commissions and fees during the purchase. Let’s understand the breakdown.

Initial Investment Cost: 100 shares * $10 per share = $1,000

Sales Proceeds: 100 shares * $15 per share = $1,500

Profit: Sales Proceeds ($1,500) - Initial Investment Cost ($1,000) = $500

Now, as mentioned earlier, you need to divide this profit in half to determine your taxable capital gains:

Purchase cost: 100 shares x $10 per share = $1000

Adjusted cost base (ACB): $1000 (purchase cost) + $100 (commissions and fees) = $1,100

Sales Revenue: Selling 100 shares at $15 per share results in proceeds of $1,500

Net Profit: After subtracting the Adjusted Cost Base (ACB), your profit from the sale is $1,500 (proceeds) - $1,100 (ACB) = $400

Considering all costs, this $400 profit constitutes your capital gains. You need to understand that you are only obligated to pay 50% of your capital gains. This means that you should divide the amount in half for the tax calculations.

This means that for this stock sale, you add $200 to your taxable income for the year. The capital gains tax rate applied to this $200 will depend on various factors, including your total income, deductions, and other aspects of your tax return. The actual rate can vary, so it's advisable to consult with a tax professional or refer to the current tax laws for accurate information.

How do avoid capital gains tax in Canada?

Here are some ways to manage your capital gains tax:

1. Primary residence exemption

When you sell your primary residence, any capital gains are generally tax-exempt. This is one of the most significant tax breaks available in Canada. However, if you own more than one property, only one can be designated as your primary residence in a given year.

2. Tax-Free Savings Account (TFSA)

Investments held in a TFSA grow tax-free, and any capital gains realized within the account are not subject to capital gains tax.

3. Registered Retirement Savings Plan (RRSP)

When you sell investments held within an RRSP, the capital gains are not subject to tax as long as they remain within the RRSP. However, when you withdraw funds from your RRSP, they are taxed as income.

4. Use of capital losses

You can offset capital gains with capital losses from other investments. If you have incurred capital losses in a tax year, you can use them to reduce your capital gains tax liability.

5. Donations of securities

If you donate publicly traded securities to a registered charity, you can eliminate the capital gains tax on those securities. You'll receive a donation receipt for the fair market value of the donated securities.

6. Lifetime Capital Gains Exemption (LCGE)

Certain small business owners may be eligible for the LCGE, which can provide significant tax savings when selling qualified small business shares or assets. The LCGE limit is subject to change and varies depending on the type of asset.

7. Timing of sales

Consider spreading out the sale of assets over multiple years to stay within lower tax brackets and reduce the overall capital gains tax liability.

8. Use of spousal attribution

If you are in a higher tax bracket than your spouse or common-law partner, you can use spousal attribution rules to allocate capital gains to the lower-income spouse, potentially reducing the overall tax liability.

9. Professional advice

Seek advice from a tax expert or financial consultant who can offer customized recommendations tailored to your specific financial circumstances and objectives. Their expertise can assist you in crafting tax-efficient strategies.

10. Use of capital gains deduction

Certain individuals, such as farmers, fishers, and small business owners, may be eligible for the lifetime capital gains deduction on the sale of qualified assets. The rules and limits vary depending on the type of business and asset.