What are capital gains and how do they affect me?
A capital gain (or loss) typically results when you sell or are considered to have sold capital property. The most common capital gains are realized from the sale of stocks, bonds and property. Gains can also be triggered in other ways such as when you give property or investments as a gift, transfer property to a trust or when the owner passes away.
When completing your income tax return, a “Schedule 3” must be completed to outline these gains or losses and the corresponding amounts must be reported on your return. In order to do this calculation, you must first calculate the Adjusted Cost Base (ACB). In general terms, the ACB is the cost of a property plus any expenses that were incurred to acquire it such as investment fees/commissions and legal fees. Your capital gain or loss is then calculated by taking the sale price and subtracting the ACB. For example, if you purchase a stock for $50 and sell it 5 years later for $100, your capital gain is $50.
What if the stock goes down? If you purchase the same $50 stock from above and sell it for $25, you would have a capital loss of (-$25) to report on your tax return. If you have other capital gains in the same year, this loss can be used to offset the gains and reduce your tax liability. If there are no other capital gains, the losses can carried back up to 3 previous years or carried forward indefinitely to be used against other gains. Although many people don’t always do so, it’s extremely important to report your capital losses as well as your gains so that they can be used for future tax planning purposes.
Currently, 50% of realized capital gains are taxed in Canada at an individual’s marginal tax rate or at a corporation’s normal corporate tax rate. Let’s take another look at our example:
- 50% of the $50 capital gain from above would be taxable – $50 x 50% = $25
- Assuming an individual makes $50K/year they would be at a 29.7% marginal tax rate
- $25 x 29.7% = $7.43 of taxes owing on the $50 profit from the stock that was sold.
By utilizing tax efficient investment strategies and other exemptions offered by the Canada Revenue Agency, this capital tax may not be payable at all. Some key exclusions/exemptions are:
RRSPs – When you sell an investment inside your RRSP, the gains are not taxable yet. The taxes do not come due until you actually pull the money out of your RRSP.
Personal Home – When you sell your principal residence, you don’t have to report the sale on your tax return and you do not have to pay tax on any gain from the sale IF your home was your principal residence for every year that you owned it.
TFSAs – Any gains or growth inside of a Tax Free Savings Account is exempt from taxation.
Tax Efficient Investments – There are multiple tax efficient investment options that allow you to minimize and defer taxation on the gains that are achieved. Capital yield funds, corporate class options and segregated funds are a few of the vehicles available and should be discussed with an advisor who fully understands their features.
While taxation is a fact of life, there are many ways to protect your assets from taking a heavy hit. For those with non-registered investments in particular, make sure you’re doing everything you can to maximize your tax planning options.
NOTE: Insurance products provided through multiple insurance carriers. Mutual funds products are offered through Investia Financial Services Inc.