In this article, we discuss what is a capital gain, what is the capital gains tax Canada rate, how to calculate tax on a capital gain and avoid capital gains if you are living in Canada.
Capital Gains Tax Canada: A Quick Explanation and Tips!
What is capital gain?
A capital gain is an increase in the value of an investment,
They can be either stocks or shares in a mutual fund or exchange traded fund,
A capital gain is also a real estate holding from the original purchase price.
Such as if the value of the asset increases, you have a capital gain requiring you to pay tax on it.
Since it is a gain, this is an added benefit for your investments.
One good news, you only pay tax on realized capital gains, which will be explained more below.
What is a “realized” or “unrealized” capital gain?
Capital gains can be “realized” when an investor sells the investment or real estate for more than they purchased it for.
An unrealized capital takes place when your investments increase in value, but you haven’t sold them.
As an investor, there are benefits for unrealized capital because an investor would only pay tax on realized capital gains. This works by understanding that until you “lock in the gain” by selling the investment, it’s only an increase on paper.
What is capital loss?
When the value of your investment or real estate holding decreases in value, a capital loss occurs.
You have a capital loss if the current value of the investment or holding is less than the original purchase price.
In addition, capital losses can be used to offset capital gains and reduce the overall tax you will pay. In other words, as an investor you can carry capital losses back 3 years or forward into future years.
When do capital gain and capital loss matter?
If you have investments in registered plans such as a Registered Retirement Plan (RPP), Registered Retirement Savings Plan (RRSP), or Registered Education Savings Plan (RESP), you as an investor need not worry about capital gains and losses because the investments are tax-sheltered.
This enables investments to grow and you don’t have to worry about changes in value until you withdraw the funds. That means that if you have non-registered investments, capital gains is something you need to focus on!
What is the capital gains tax rate in Canada?
In the Income Tax Act, there is no special tax relating to gains you make from investments and real estate holdings.
Instead, as an investor one would pay the income tax on part of the gain that they make.
50% of the value of any capital gains are taxable in Canada.
If an investor was to sell the investments at a higher price than what they paid (realized capital gain) — the investor will need to add 50% of the capital gain to their income. This means the amount of additional tax an investor actually pays will vary depending on how much they are making and what other sources of income the investor has.
If an investor was to have both capital gains and capital losses, they can offset the capital gains with capital losses until they reach zero. If an investor only has capital losses, the CRA permits them to use the capital loss to offset a capital gain they first declared originally in the previous 3 years, or they are allowed to carry forward the capital loss into the future.
Right now how distant into the future is indefinitely unknown, so don’t lose the paperwork! While the rules can change, as an investor check with your tax professional before taking any action.
How to calculate tax on a capital gain?
Rather than calculate your capital gains, the first thing you’re going to need is to figure out something called the adjusted cost base.
The adjusted cost base is the starting point for determining:
- if you have made or
- If you have lost money on your investments.
The adjusted cost base sounds scarier than it is but the truth is that a majority of financial institutions will track your capital gains and adjusted cost base for you so there might be no need for you to calculate it at home.
While that is true, if you as an investor owns a self-directed account and need to calculate tax on a capital gain — start by calculating the adjusted cost base:
Adjusted cost base = Book value (the original purchase price of the investment), in addition to the costs to acquire it, such as fees.
After you’ve calculated the adjusted cost base, you can now figure out the amount of money that is taxable:
Capital gain subject to tax = Selling price (net of fees) minus the adjusted cost base.
The difference between the adjusted cost base and the selling price of your asset is the sum of money that’s taxable.
You can have different ACBs, if you buy shares at different times in the same fund depending on the book value at the time of the transactions.
How to reduce capital gains tax Canada?
Take advantage of “tax advantaged accounts”
Capital gains attain the most preferential tax treatment of interest, dividends, and capital gains, therefore compelling you as an investor to hold investments such as shares, stocks, and mutual funds in a non-registered account. This way you let go or leave the higher-taxed items in a registered vehicle aka a place where they can grow tax-sheltered.
Get into donating assets to charity
you receive a tax receipt when you make a donation to a registered charitable institution, which allows you to deduct a portion of your donation from income tax owing.
you can transfer ownership of stocks to the registered charity rather than making a donation in cash.
An “in kind” transfer is a way of rebalancing your portfolio without triggering a capital gain.
You are simply transferring ownership because you are not selling the stock and as an investor, you will also receive a tax receipt for the current fair market value (what the stocks would sell for as of the day of the transaction).
To follow the correct procedure, consult a tax professional before you do so.
Carry over losses to the next year
Remember capital losses offset capital gains so if an investor has both capital gains and capital losses in the same tax year, they must use them to offset the capital gain.