Capital gains tax is one of the three main tax pillars in Canada, alongside interest and dividends. A form of investment income, capital gains tax, is 50% taxable nationwide, though there have been talks about adjusting that percentage. For high earners, the marginal tax rate on capital gains can be as high as 27%.
Compared to dividends and interest, capital gains are the most tax-advantaged type of investment income. But how many capital gains advantages are there? And what are the cons you should consider regarding this type of tax in Canada? Here are some notables to consider.
First, Understand How Capital Gains are Taxed
As mentioned above, capital gains are 50% taxable. Therefore, how much tax you pay on it will depend on the income you’ve made for a given year. To determine how much tax you owe, half of the amount you made from selling an investment will be added to your income before a personal tax rate is incurred.
By contrast, if you sell an investment for less than you paid for it, that’s called a capital loss. This can be applied against the capital gains you accrued throughout the year to reduce any taxes you owe on that amount.
What are the Capital Gains Tax Advantages in Canada?
From tax deferrals to potential long-term benefits, there are many potential capital gains tax advantages for earners nationwide.
Deferral of Taxes
Before you sell an asset, capital gains tax allows you to defer tax payments until the sale is complete. For instance, if you’re a real estate investor, you don’t pay taxes on any equity that’s gained while investing in a property until the year you sell your property for profit. Alternatively, if you’re a securities investor, you won’t pay capital gains tax on any profits you’ve made from stocks or bonds until you take a distribution. You can also defer the tax until the asset has been sold.
Capital gains tax provides this bit of leeway for you compared to income tax where you’ll have to pay taxes anytime you receive income payments.
Facilitates Benefits for Estate Planning and Businesses
According to Canadian tax rules, when you pass away, it’s assumed that your assets have been sold immediately before your death at fair market value. If your assets have accumulated a pregnant gain, your estate will then face a capital gains tax.
However, your beneficiaries will inherit your assets with an improved cost base. And, they won’t have to pay taxes on them. By making your husband or wife the beneficiary of your estate, you defer your exposure to the death tax. Alternatively, you can establish a qualifying spousal trust.
Government rules dictate that if a spouse buys back stock or mutual funds within 30 days of selling it, the spouse cannot claim a capital loss for tax reasons. This 30-day rule is called the superficial loss rule. Any failure to adhere to the rule will render the capital loss null and void.
Should you own a business, operate a farm, or run a fishery in Canada, you can qualify for a lifetime capital gains exemption. You can reduce your capital gains thanks to the exemption amount when you’re selling a business.
What are the Capital Gains Tax Disadvantages in Canada?
Pretty much anything that you own for investment purposes or personal reasons is considered a capital asset. For government purposes, a capital asset includes assets that are acquired, built or developed with the intention of using them regularly. These assets also include betterments.
The issue with capital assets is that you will have to report your gains as income on your next tax return whenever you sell them and make a profit. This means you won’t be able to reap the full profits of the capital assets you have sold.
How Can You Keep More Capital Gains for Yourself
For Canadians, the sales of principal residences are not subject to capital gains tax. Additionally, any donation of securities to registered charities or foundations don’t lead to the imposition of capital gains tax.
Whenever you sell an asset for capital gains but aren’t getting the money in the immediate future, you can claim a reserve or defer your capital gains until sometime down the road.
Capital losses from alternative investments can be used to offset the impact of capital gains. However, if you don’t have any capital gains, capital losses cannot be claimed against regular income. The exception to this rule is some small business corporations.
Capital gains tax in Canada can be helpful to taxpayers who desperately need to defer their taxes. However, they will put a cap on your earning potential from your capital assets when you decide to sell them. And, how much of a tax advantage you’ll benefit from will depend on the marginal tax rate in your province.
Ryan Faridan is the Principal Advisor at Global Solutions West, an advisory company dedicated to wealth preservation and long-term financial stability. With nearly a decade of experience in risk management, tax planning, and insurance, Ryan has made a name for himself as a Canadian wealth preservation expert.