Selling your high-performing stocks or your investment property can reap significant profits, and those moments are worth celebrating. But while you’re enjoying the spoils of your investments, keep in mind that you’ll eventually have to pay tax on them. In Canada, most gains on capital assets are taxed.
What is a Capital Gain or Capital Loss in Canada?
In simple terms, a capital gain is an increase in the value of an investment (such as stocks or shares in a mutual fund or exchange traded fund) or real estate holding from the original purchase price. If the value of the asset increases, you have a capital gain and you need to pay tax on it.
A capital loss occurs when the value of your investment or real estate holding decreases in value. If the current value of the investment or holding is less than the original purchase price, you have a capital loss. Capital losses can be used to offset capital gains and reduce the overall tax you will pay. You can carry capital losses back 3 years or forward into future years.
Capital Gains vs. Interest and Dividend Income
There are three main forms of investment income in Canada: interest, dividends and capital gains. It’s important to understand how different types of investment income is calculated for income tax.
- Capital gains: In Canada, only 50% of the total capital gains is taxable. It is included in your annual taxable income and taxed at your marginal tax rate. Capital gains only apply when you sell an asset at a profit.
- Interest Income: The money earned in the form of interest on assets, such as bonds and GICs, is taxed at the same marginal tax rate as ordinary income. For example, $100 interest earned on a 1-year GIC must be included in your annual total income.
- Dividend Income: The money earned in the form of stock dividends is taxed at a lower tax rate than interest income. Canadian dividend-paying stocks may be eligible for the dividend tax credit. For eligibility and calculation, please visit CRA site.
How are capital gains calculated? How are they taxed?
In Canada, it’s incorrect to assume that capital gains are taxed at a rate of 50% consistently or that they are taxed completely at your marginal tax rate.
Instead, you only owe half of the increased value, or capital gain, on any given sale that is then taxed at the marginal tax rate, both federally and provincially. Both federal and provincial tax brackets are broken down into five tiers according to income, and you are only taxed the minimum tax rate according to how much money you made and what tier that amount falls into.
Each bracket pays a different rate of tax, as the table below shows:
Federal income tax
| 2021 Federal income tax brackets* | 2021 Federal income tax rates |
| $49,020 or less | 15% |
| $49,020 to $98,040 | 20.5% |
| $98,040 to $151,978 | 26% |
| $151,978 to $216,511 | 29% |
| More than $216,511 | 33% |
* These amounts are adjusted for inflation and other factors in each tax year.
Before you can calculate your capital gain on an investment, there are some terms you need to be aware of.
- The Proceeds of Disposition– What you will receive or have received for the sale.
- The Adjusted Cost Base (ACB)– The cost of the investment plus any expenses paid to acquire it, like commissions and legal fees.
- The Outlays and Expenses– These are any costs incurred to sell your investment, such as renovations, maintenance expenses, commissions and finders fees.
The equation to calculate capital gains uses the values above and is laid out as follows:
Proceeds of disposition – (ACB + outlays and expenses) = capital gain
If the amount is less than the proceeds of disposition, then what you have is a capital loss that can be used to offset other capital gains in the future or up to three years in the past.
Can you avoid capital gains tax?
It’s not so much that you can avoid capital gains tax, but that there are CRA rules that you can take advantage of to reduce the amount you may owe. Here are a few:
- Principal residence exemption: The CRA will allow the sale of your primary residence to be tax exempt as long as it was your principal place of residence for every year that you owned it.
- Use tax-free or tax-sheltered accounts: A tax-free savings account (TFSA) can help you avoid capital gains tax. The income you earn in a TFSA, regardless of the type of income, is not taxable, even when the gain is realized. Funds withdrawn from a TFSA are also not taxable.
- Use capital losses to axe your capital gains: A capital loss occurs when you lose money because your home (or other asset) decreases in value. As with capital gains, the loss is “realized” when you sell your home and “unrealized” if you continue to hold onto it. The CRA allows you to use your capital losses to offset your capital gains down to zero.
- Time the sale of your property for when your income is the lowest: Because the amount of capital gains tax charged is based on your income tax bracket (among other things) it’s smartest to time the sale of property for when your earnings are at their lowest so that your tax rate is lower. This could be if you or your spouse go on maternity leave or if you take a leave of absence from work, for example. The goal with this strategy is to sell your property in a year when your overall income is low to avoid paying higher tax o the asset.
- Utilize the capital gain reserve: Profits from capital asset sales can be spread over five years. Canada’s progressive income tax system means that every dollar earned above our basic needs is taxed more heavily. Consider the following: Selling a capital asset to your children leads to a $250,000 profit. BC’s marginal tax rate is 43.41 percent. The marginal tax rate reduces to 20.05 percent if you spread the gain over five years, earning $50,000 per year.