What is capital gains tax in Canada?
As an investor, few things are as rewarding as watching your investments grow — but knowing some of those gains may be taken away by tax can be deflating. Since 1972, Canada has imposed a tax on capital gains. Capital gains represent the growth or profit you make on an investment over time, measured as the difference between what you pay for an asset and what you sell it for.
Only half of your capital gains are subject to tax at your marginal tax rate, which is determined by your income. If you’re in the lowest tax bracket, that marginal rate could be as low as 15%. Consider the following example. On a $1,000 capital gain, $500 of that gain would be taxable. If you were in the lowest tax bracket, your potential tax bill on that gain might be $75 — ignoring any factors that might lower your tax bill.
What are capital gains?
A capital gain is triggered when an asset held outside a registered account, such as a stock, bond or investment property, is sold for more than its adjusted cost base (ACB). The ACB is the purchase price of the investment, plus any acquisition costs, such as commissions or legal fees. In Canada, 50% of the capital gain is taxable. For example, if you purchased a stock for $500 and later sold it for $1,000, the $500 difference between the purchase price and the sale price represents your capital gain. Of the $500 in capital gains, $250 is taxable (i.e., 50% of the capital gain)
Capital gains tax rate:
There is no specific capital gains tax rate. Instead, the taxable portion of the capital gain is included in your annual taxable income and taxed at your marginal tax rate, which is based on your income level and where you live.
Assets subject to capital gains:
Not all asset sales are subject to capital gains. The most notable exception is the sale of a primary residence — usually the family home. Any asset sold within a registered or tax sheltered account, like a Tax-Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP) or a Registered Education Savings Plan (RESP), and now a First Home Savings Account (FHSA) is exempt from a targeted capital gains tax — although withdrawals from RRSPs and RESPs are taxed at the investor’s marginal tax rate as ordinary income. RESP withdrawals can be a little trickier. That’s because, while contributions can be withdrawn tax free, the grant and income portion (known as the Educational Assistance Payments or EAP) are taxed in the hands of the beneficiary — the student.
When capital gains apply:
Capital gains generally apply when assets outside of a tax sheltered account are sold for a profit. A capital gain can also occur with a “deemed disposition,” which is a tax event that happens at death or if you cease to be a tax resident of Canada. It can also be triggered by an estate freeze — a process where you can freeze the value of your appreciating assets (often involving the use of a corporation or trust) at their current market rates or when an investment asset is donated or transferred. The disposition is treated as a sale at the fair market value.
What is capital loss?
A capital loss occurs when you sell an asset for less than its ACB outside a registered account. For instance, when a stock is sold at a value lower than what it was purchased for. While you are not taxed on any losses you suffer on your investments, you may put those losses to work to lower your tax bill on other capital gains. This strategy, known as “tax-loss harvesting,” allows you to use your net capital losses to offset any capital gains you may have earned in the past three years or in any future year until you’ve taken full advantage of it. Remember, this strategy only applies to capital losses earned outside of your registered accounts — RRSPs, RESPs, TFSAs and FHSAs.
When do you pay tax on capital gains in Canada?
Taxable capital gains must be reported as income on your tax return in the year the asset was sold. If you experienced a capital loss outside of your registered account, you could use it to offset your capital gains to reduce your tax bill. You can also carry-back net capital losses to offset any capital gains you’ve earned in the past three years. To make this adjustment, you need to complete a special tax form.
How to avoid capital gains tax in Canada
There are several types of investments that are not subject to any capital gains tax in Canada. Here are a few examples:
• Capital gains on the sale of property
There is no capital gains tax on the sale of a primary residence in Canada. The Canada Revenue Agency (CRA) will only allow the principal residence exemption, however, if the disposition and designation of a principal residence are made on a taxpayer’s income tax and benefit return. Canadians must also report any gains for the years the property wasn’t their principal residence.
Capital gains apply to second properties in Canada, including vacation homes or investment properties.
• Capital gains in registered accounts
Canadians can also mitigate the impact of capital gains tax by purchasing assets in certain registered investment vehicles, such as an RRSP, RESP, TFSA or FHSA. However, there are some nuances. Both TFSAs and FHSAs allow you to enjoy your capital gains without affecting your taxable income. You also won’t be subject to any tax on capital gains earned within an RESP or RRSP. However, your withdrawals from an RRSP are taxed as income. In the case of an RESP, the withdrawal of the original contribution is not taxed, but the Educational Assistance Payments (EAP) — which is comprised of the grant and any capital gains — is taxed as income. Having said that, the EAP withdrawn from an RESP will likely be taxed at a lower rate because it is taxed in the hands of a student who presumably has a low income.
• Tax-loss harvesting
Canadians can also offset capital gains through tax-loss harvesting. For example, an investor who gains $2,500 on a stock and loses $2,500 on another stock can eliminate paying capital gains tax because the win and loss cancel each other out. Similarly, if you earn $500 on a stock, but have a capital loss of $750 from another investment, you can offset the gain of $500 and apply the remaining $250 from that capital loss to a gain later. A net capital loss can be carried backward for up to three years to offset gains or carried forward indefinitely.
• Investment donations
Another tax planning strategy is to donate capital assets directly to a registered charity. By doing this, you don’t have to include a capital gain on your income and you can receive a donation tax credit based on the market value of the assets.
• Capital gains exemptions
If you’re a small business owner, it’s possible to reduce or eliminate capital gains tax when you sell your company. Canada has a lifetime capital gains exemption (LCGE), up to a certain amount that is indexed annually. The LCGE for the 2022 tax year is $913,630, although since only half of the gains from these properties are taxable, the deduction is equal to $456,815.
Are dividends taxed differently than capital gains?
Dividend income is taxed differently than capital gains. When you sell an asset in an unregistered account, 50% of the profit is taxable. This is included in the investor’s annual taxable income at their marginal tax rate. However, income from Canadian eligible dividends is taxed at a higher rate than capital gains income but the investor may be eligible for the dividend tax credit.
What percentage of your capital gain is taxable?
In Canada, 50% of the total capital gain from the sale of an asset is taxable. Of course, that doesn’t mean you are losing half your earnings to tax, it just means that a portion of your capital gain will be taxed at your marginal rate.
Can you defer capital gains?
There are a few times when capital gains can be deferred. If you sell a property and receive the amount over several years, you may only have to report the portion of the capital gain in the year you received it.
Another example is when you receive an asset such as shares from a spouse due to death or divorce. In that instance, you would only pay tax on your capital gains when you sell the shares, although the capital gain will be based on when the spouse purchased the stocks, not when they were transferred.