Capital Gains Tax Canada: All You Need to Know

Many years ago, the Canadian Government brought about a major cut in the capital gains inclusion rate. The government’s new regulation stated that you needed to only consider 50% of your capital gains as income instead of the earlier figure of 75%.

For example, if an investor purchases stock for $1,000 and then sells that stock for $2,000, then they will have a $1,000 capital gain. Investors have to pay Canadian capital gains tax on 50% of the amount of capital gain. This means that if you earn $1,000 in capital gains, and you are in the highest tax bracket in, say, Ontario (53.53%), you will pay $267.60 in Canadian capital gains tax on the $1,000 in gains or only $500 will be taxed out of the $1,000 you gained.

Interests and dividends make up the other types of investment income. Interest income is 100% taxable in Canada, while dividend income is eligible for a dividend tax credit in Canada. If you are in the 53.53% tax bracket, you’ll have to dish out $535.30 in taxes on $1,000 in interest income. If you have $1,000 worth of dividend income, you will only have to pay $316.20 in taxes.

Capital Gains Tax Canada: Things to Keep in Mind

What are some capital-gains strategies?

Canada’s capital gains tax is a lot lower than the prevailing taxes on interest and dividend income. This makes income through capital gains a very tax-advantaged form of income. However, if you are an investor, you will most likely earn money through all the three channels. Here are three ways you can strategize your capital gain in order to minimize your tax burden:

  • It is usually best to hold any common shares outside of an RRSP (as dividend income and capital gains taxes are taxed lower than interest income), and interest-paying investments in an RRSP. (At the same time, though. it’s okay to hold common shares in an RRSP–especially if you don’t hold any fixed-income investments.)
  • Hold your speculative investments outside RRSP. If investors hold them in an RRSP and they drop, investors not only lose money, but they can’t use the losses to offset any taxable gains from other investments.
  • Regarding mutual funds outside an RRSP, the main consideration is that mutual funds make annual capital gains distributions even if investors continue to hold the fund units. Investors then pay Canadian capital gains tax on half of any realized capital gains. It’s always better to hold RRSPs and common stocks outside. You won’t realize capital gains on common stocks until you sell.

A properly structured investment portfolio can let you take advantage of the low tax rate on capital gains and dividend income while sheltering your higher-taxed interest income in your RRSP. If you make dividends or capital gains in an RRSP, you gain the tax shelter of the RRSP, but when you withdraw the funds from your RRSP they are taxed at the same rate as interest income. This might result in you losing out on the lower tax rates offered by the Government of Canada.

Should you sell your stocks?

Stock prices tend to move in short spurts, interrupted by lengthy periods when they mainly move sideways. For this reason, sometimes investors who only focus on price, rather than the fundamentals of their investments, may make changes just for the sake of change.

While selling stocks out of boredom might not lead to massive immediate losses, but it will definitely lead to reducing your long term returns. There will be times when the top performers of the market will bore you out of your mind. However, even though they may go sideways for a long time, these stocks may then set off on a big rise. If you sell out of boredom, you would miss that rise.

In case you do decide to sell your stocks, go through these tips before you actually unload them off your portfolio:

  • Be quicker to sell low-quality stocks, and slower to sell shares of high-quality stocks.
  • Before you sell, ask yourself this: does the stock have a poor fundamental outlook? Or do you want to sell because it just isn’t going up fast enough (see boredom above)?
  • Avoid portfolio tinkering, especially when it comes to selling stocks that you feel have gone up too far and too fast. To succeed as an investor, you need a big winner in your portfolio from time to time. One key fact about big winners is that they tend to go up further and faster than most investors expect, and they keep doing it for years if not decades.

What is the superficial loss rule?

In case you are thinking about utilizing tax loss selling for minimizing capital gains in Canada, knowing about the superficial loss rule could be very helpful for you. According to this rule, if an investor, their spouse or a company they control, buys back a stock or mutual fund within 30 days of selling it, then they are not permitted to claim the capital loss for tax purposes. Failing to obey the 30-day rule will result in the capital loss being disallowed.

When do you have a capital gain or loss?

A capital gain or loss is generated when you sell capital property. According to the Government of Canada website, these are examples of cases where you are considered to have sold capital property:

  • You exchange one property for another.
  • You give property (other than cash) as a gift.
  • Shares or other securities in your name are converted.
  • You settle or cancel a debt owed to you.
  • You transfer certain property to a trust.
  • Your property is expropriated.
  • Your property is stolen.
  • Your property is destroyed.
  • An option that you hold to buy or sell property expires.
  • A corporation redeems or cancels shares or other securities that you hold (you will usually be considered to have received a dividend, the amount of which will be shown on a T5 slip).
  • You change all or part of the property’s use. 
  • You leave Canada 
  • The owner dies 

Disposing of Canadian securities

According to the Government of Canada’s website “If you dispose of Canadian securities, it’s possible that you could have a gain or loss on income account (as opposed to the more likely capital gain or loss). However, in the year you dispose of Canadian securities, you can elect to report such a gain or loss as a capital gain or loss. If you make this election for a tax year, the CRA will consider every Canadian security you owned in that year and later years to be capital properties. A trader or dealer in securities (other than a mutual fund trust or a mutual fund corporation) or anyone who was a non-resident of Canada when the security was sold cannot make this election.”

In case of the securities being owned by a partnership, every single partner is treated as the security owner. “When the partnership disposes of the security, each partner can elect to treat the security as capital property. An election by one partner will not result in each partner being treated as having made the election,” according to the Government of Canada website.

In order to make this election, people need to fill Form T123, Election on Disposition of Canadian Securities, and attach it to their income tax and benefit return. This election decision is irreversible. However, most people stay unaffected by capital gains rules as their property is generally for personal use and recreation.

Personal-use property

According to the Government of Canada’s website, “When you sell personal-use property, such as cars and boats, in most cases you do not end up with a capital gain. This is because this type of property usually does not increase in value over the years. As a result, you may end up with a loss. Although you have to report any gain on the sale of personal-use property, generally you are not allowed to claim a loss.”

Principal residence

If you sell your home for more than what it cost you, you usually do not have to pay tax on any gain if you meet all of the following conditions:

  • your home was your principal residence for all years you owned or for all years except one year
  • you report the sale of the property and designate it as your principal residence on Schedule 3 and complete Form T2091(IND)
  • you or a member of your family did not designate any other property as a principal residence while you owned your home.

What to do when you get a capital gain?

Here are your options after receiving capital gain:

  • defer part of the capital gain by “claiming a reserve”
  • reduce or offset all or a part of the gain by claiming a capital gains deduction 

What does it mean to claim a reserve?

When you sell a capital property, you usually get the full payment immediately or you receive it in a deferred way over the years. For example, you sell a capital property for $50,000 and receive $10,000 when you sell it and the remaining $40,000 over the next 4 years. In this scenario, you may be able to claim a reserve. Usually, a reserve allows you to report a portion of the capital gain in the year you receive the proceeds of disposition.

Who can claim a reserve?

Anybody who sells capital property can claim a reserve in a given tax year except if:

  • You were not a resident of Canada at the end of the tax year, or at any time in the following year.
  • You were exempt from paying tax at the end of the tax year, or at any time in the following year.
  • You sold the capital property to a corporation that you control in any way.

How do you calculate and report a reserve?

According to the Government of Canada website, “If you claim a reserve, you still calculate your capital gain for the year as the proceeds of disposition minus the adjusted cost base and the outlays and expenses incurred to sell the property. From this, you deduct the amount of your reserve for the year. What you end up with is the part of the capital gain that you have to report in the year of disposition.”

In order to deduct a year’s reserve, you need to fill Form T2017, Summary of Reserves on Dispositions of Capital Property. The information on the back of Form T201 will explain the whole process in detail and you can use it in case you face any difficulty calculating your reserve. 

What is the period over which reserves can be claimed?₹

Generally, the maximum period over which most reserves can be claimed is 5 years. However, a 10 year reserve period is provided for transfers to your child of family farm or fishing property (which includes shares of a family farm or fishing corporation, an interest in a family farm or fishing partnership, as well as land or depreciable property in Canada that you, your spouse or common-law partner, your parent or any of your children used in a farming or fishing business), and small business corporation shares, as well as gifts of non-qualifying securities made to a qualified donee.

The following people qualify as children:

  • a person of whom you or your spouse or common-law partner is the legal parent
  • your grandchild or great-grandchild
  • your child’s spouse or common-law partner
  • another person who is wholly dependent on you for support and who is, or was immediately before the age of 19, in your custody and under your control

Always include your claimed reserves from the previous years in the calculation of your capital gains for the current year. So, if you claimed a reserve in 2019, you have to include it in your capital gains calculation for 2020. Claim the new reserve that you have calculated for 2020 in the appropriate area on Form T2017. If you still have an amount that is payable to you after 2020, you can calculate and claim a fresh new reserve. But, that must be included in your capital gains calculation for 2021. “A capital gain from a reserve brought into income qualifies for the capital gains deduction only if the original capital gain was from a property eligible for the deduction,” per the Government of Canada website.

What is the limit for capital gains deduction in Canada?

Per the Government of Canada website, these are the limits for various capital gains deduction in Canada:

  • For 2019, if you disposed of qualified small business corporation shares (QSBCS), you may be eligible for the $866,912 LCGE. Because you only include one-half of the capital gains from these properties in your taxable income, your cumulative capital gains deduction is $433,456 (1/2 of $866,912).
  • For dispositions of qualified farm or fishing property (QFFP) in 2016 to 2019, the LCGE is $1,000,000. Because you only include one‑half of the capital gains from these properties in your taxable income, your cumulative capital gains deduction is $500,000 (1/2 of $1,000,000).
  • The capital gains deduction limit on gains arising from dispositions of QSBCS in 2018 is $424,126 (1/2 of a lifetime LCGE of $848,252).
  • The capital gains deduction limit on gains arising from dispositions of QSBCS in 2017 is $417,858 (1/2 of a lifetime LCGE of $835,716).
  • The capital gains deduction limit on gains arising from dispositions of QSBCS in 2016 is $412,088 (1/2 of a lifetime LCGE of $824,176).
  • The limit on gains arising from dispositions of QSBCS and QFFP in 2015 is $406,800 (1/2 of a lifetime LCGE of $813,600). For dispositions of QFFP after April 20, 2015, the LCGE is $1,000,000. The additional deduction is calculated as the difference between $500,000 (1/2 of $1,000,000) and the $406,800 limit.
  • The limit on gains arising from dispositions of QSBCS and QFFP in 2014 is $400,000 (1/2 of a lifetime LCGE of $800,000).
  • The limit on gains arising from dispositions of qualified farm property, qualified fishing property or QSBCS after March 18, 2007 and before 2014 is $375,000 (1/2 of a lifetime LCGE of $750,000).

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