As first-time homeowners or budding investors, we always make the best in our situations to ensure the highest value is placed on our assets – but what about capital gains tax?
You should understand how capital gains are taxed and learn to avoid paying more taxes when selling your properties.
What are capital gains?
If you are unfamiliar with capital gain, it happens when you sell an asset or investment for more than the price you paid.
For example, if you purchased a property for $50,000 and sold it for 60,000 two years later, you would have a capital gain of $10,000.
On the other hand, when you sell an asset for less than its original purchase price, that’s called a capital loss.
Capital gains and losses can occur with many types of investments and property, including;
- stocks
- bonds
- shares in mutual funds and exchange-traded funds (ETFs)
- rental properties
- cottages
- business assets
Capital gains generally do not apply to some types of personal-use property, such as cars and boats, whose value tends to decrease over time.
If you have recently moved to Canada, capital gains are taxable here, and the value of a capital gain is treated as income earned during the tax year in which it was realised.
What is the rate in Canada?
Did you know a third of Canadians mistakenly believe that the entire capital gain is taxed at 50%? In reality, only 50% of capital is taxable, and the rate depends on where you fall within the federal and provincial income tax brackets in the year you report the gain.
The higher your total annual income, the more tax you can expect to owe on a capital gain – which will be added to your taxable income.
Suppose you make a $50,000 profit this year. When you file your taxes next year, you must report half of that, which is $25,000, as income. If your tax rate is 33%, you’ll owe $8,250 in taxes on this additional income, leaving you with $41,750. If your tax rate is 26%, you’ll owe $6,500 and keep $43,500.
How to avoid or minimise capital gains
There’s no way out of paying taxes, and you could face an interest penalty for failing to pay your taxes or missing a tax deadline. Tax evasion is illegal in Canada, but you have the right to seek paying the least amount of tax possible within the law. It’s no different with capital gains. Here are some ways to legally reduce the capital gains tax you owe in Canada.
- Understand how capital gains are calculated.
Knowing which expenses to account for in calculating a capital gain can help reduce the amount, saving you from paying more taxes than necessary.
For example, renovations, transfer taxes and legal fees can be deducted from the proceeds of disposition on the sale of a property to reduce the capital gain on real estate.
- Hold your investments in a registered account.
One of the easiest ways to avoid paying taxes on capital gains is to hold your investments in a registered account, such as a registered retirement savings plan (RRSP), tax-free savings account (TFSA), first home savings account (FHSA) or written education savings plan (RESP).
- Claim a capital loss from other investments.
You don’t pay any tax on capital losses; they can help offset the taxes you would otherwise spend on capital gains until the balance of capital gains for the year is reduced to zero.
- Claim the principal residence exemption.
Residential properties are considered an “asset” and are therefore subject to capital gains tax. There is one big exception to this rule. It’s called the principal residence exemption. A home that has served as your principal residence is exempt from capital gains tax as long as it meets the following criteria:
- You own the home either alone or jointly with another person
You have designated the property as your principal residence with the CRA.
You, your spouse, your common-law partner or your kids inhabited the home each year for which the exemption is claimed.
Canadians, ready to claim your capital gain?
Remember, the amount you end up paying in tax will depend on how much your asset has grown in value and your other sources of income.
And between tax-sheltered investment accounts, the principal residence exemption and the rules around capital losses, there are many legitimate ways to ensure you don’t pay more tax than necessary in any given year.