Capital Gains: What you need to know

June 5, 2024

When it comes to owning land, property, or investments, one term that often surfaces is “capital gains.” Understanding the taxation of capital gains is important for anyone involved in the buying and selling of assets (such as real estate), investments, or for those owning and operating a business. In Canada, capital gains are a significant aspect of the tax system, and planned changes later in June 2024 make it even more relevant for the public to grasp the basics.

What are Capital Gains?

Capital gains refer to the profit realized from the sale of capital property that has increased in value over the time you held it. For instance, if you purchased a property for $300,000 and sold it later for $400,000, the $100,000 profit is considered a capital gain.

Types of Capital Property

Capital property includes various types of property such as:

• Real Estate: This includes land and buildings.
• Securities: Stocks, bonds, and mutual funds fall under this category.
• Companies: Shares in a Corporation or a partnership interest.
• Personal-Use Property: Items like cottages, boats, or even artwork that are primarily for personal use.
• Investment Property: Assets purchased with the intent to generate rental income or resale profit.

Understanding the classification of your property is essential as it determines if it is taxed as a capital gain.

Principal Residence Exemption

One significant aspect of real estate is the principal residence exemption. If the property you are selling is your principal residence, you may be exempt from paying tax on the gains or profit. A principal residence is defined as a home where you or your family ordinarily reside throughout the year, and that is under half of a hectare (or 1.24 acres) in size. This exemption can apply to various types of homes, including houses, apartments, condos, and cottages, but you (and your immediate family) can only designate one property as your principal residence per year.

How are Capital Gains Taxed?

In Canada, not all of your capital gain is taxable. Only a portion of the capital gain is subject to tax. Prior to June 24, 2024, 50% of the capital gain is included in your taxable income. To illustrate with an example, this means that if you made a $100,000 profit from selling capital property, only $50,000 would be included in your taxable income for the year.

The tax you pay on your capital gains depends on your individual marginal tax rate, which is the rate at which your last dollar of income is taxed. For example, if your marginal tax rate is 30%, and you have a taxable capital gain of $50,000, you would pay $15,000 ($50,000 x 30%).

Example of Tax on Capital Gains Calculation

Let’s break down a typical scenario:

Purchase of Property: You buy a piece of land for $200,000.

Sale of Property: After a few years, the value of the land increases to $300,000, and you decide to sell it. The total sale amount is $300,000.

Capital Gain: The difference between the sale price and the purchase price is your capital gain. In this case, it is $300,000 – $200,000 = $100,000.

Taxable Capital Gain: Only 50% of this gain is taxable under the pre-June rules. So, $100,000 x 50% = $50,000.

Tax Payable: If your marginal tax rate is 30%, the tax on your capital gain would be $50,000 x 30% = $15,000.

Proposed Changes In June 2024

Starting June 25, 2024, the Canadian government has proposed several changes to the taxation of capital gains. The key proposed change is an increase to the inclusion rate. The inclusion rate for taxable capital gains is increasing from 50% to 66.7%. This means that 66.7% of your capital gain will be included in your taxable income. Using the previous example, instead of $50,000, $66,700 of your $100,000 gain would be taxable.

The increase in the inclusion rate means that more of your capital gain will be subject to tax. For instance, with the new inclusion rate of 66.7%, a $100,000 capital gain would result in $66,700 being taxable. At a marginal tax rate of 30%, you would pay $20,010 in tax ($66,700 x 30%), instead of the current $15,000. This represents a significant increase and could impact investment decisions for many Canadians.

Conclusion

Understanding how capital gains are taxed in Canada is essential for making informed financial decisions. In particular, business owners should understand the tax implications of capital gains as it guides choices about the style of business ownership, the growth of the business and the purchase or sale of particular assets. And finally, the taxation of capital gains in Canada directly impacts everyone by influencing their investment decisions, property transactions, and long-term financial planning. If you have questions about how the proposed changes to capital gains may apply to your situation, contact Shane Landreville of the RLR Business Law Group.