Capital property represents assets that can appreciate (gain) or depreciate (loss) in value. A capital gain or loss results from the sale of a capital asset (ie: an investment, stock, bond, real estate, etc.).
The capital gain is the increase in the value of the asset that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold, and must be claimed on income taxes. A capital loss is incurred when there is a decrease in the capital asset value compared to an asset’s purchase price, an asset sold at a loss. Investments in tax-sheltered vehicles like an RRSP, RRIF, TFSA, or RESP (Registered Education Savings Plan) are not subject to capital gains tax.
A taxable capital gain is 50% of a capital gain. The capital gain or loss is calculated by deducting the original cost of the asset from the proceeds received on the sale of the asset. Because only 50% of the gain is taxable, less tax is paid on capital gains than on income such as interest, which is fully taxable at your marginal tax rate. An allowable capital loss is 50% of a capital loss. It can only be used to reduce or eliminate taxable capital gains in any of the three preceding tax years or any future year, except in the year of a taxpayer’s death or the immediately preceding year.
Tax Treatment of Capital Gains
If you bought investment shares for $5,000 and sold them for $10,000, you have to declare a $5,000 capital gain in the year you sold the shares. As of 2013, the capital gains inclusion rate is 50%, so you would add $2,500 to your total taxable income on your tax return. The actual amount of tax you pay depends on your marginal tax rate. To ensure entrepreneurship and investment in the economy, capital gains are taxed more favourably than regular income.
Tax Deductions / Deferral
If you’ve incurred a capital gain, you may wish to review your portfolio in consideration of selling any unrealized investment losses to help offset the gain. If you have a significant capital gain, it can be offset by making a significant RRSP contribution, particularly if you have unused carry-forward contribution room from previous years. Flow through shares are another option for deferring taxation of a capital gain to another year.
Superficial Loss Rule
The timing of sale/purchase of assets is important to ensure you aren’t denied a capital loss. If you sell at a loss, realize the loss, and then immediately repurchase the asset, it will very likely be considered a ‘superficial loss’. You, your spouse, or anyone ‘affiliated with you’ cannot repurchase the same property within 30 days of selling. There are ways around this (a person outside your family repurchasing the asset) but the process can be complicated, and sometimes costly. Professional tax advice should be obtained.
Claiming Principal Residence
Your home is considered your principal residence, and as such, it doesn’t attract capital gains due to the Principle Residence Exemption. The CRA (Canada Revenue Agency) allows you to pick the property where you have the largest capital gain as your principal residence, and it could save you thousands in taxes. Note however, that if you own two homes, you can’t claim one and your spouse the other. There’s one principal residence for both parties and that goes for common-law couples too.
Rental Properties / Your Principal Residence
If you have a rental property, you can claim annual expenses against rental income. Part of your home can be rented out and the portion you live in can still qualify as your principal residence. However if you rent out more than half your home, you can lose your principal residence exemption. Keep meticulous records for the rental portion. The portion you receive income from, will be deducted from the value of your home, and your principal residence status would apply to the remaining value.
Transferring, Offsetting, and Deferring Capital Gain
You can transfer capital losses to offset capital gains that your spouse may have this year or in the last three years. You can also carry back capital losses for three years to offset against taxes paid in a prior year. In order to use this strategy, the capital losses must be on paper only (in other words, not realized). If you can wait to realize a profit on some assets, put it off until the New Year. For example, selling an asset in early 2015 means you can delay taxes due until you file your 2015 tax return in 2016. If you usually donate cash to registered charities, reconsider. Donating an appreciated asset can eliminate the capital gains tax and can also provide you with a donation tax credit.
There’s also a Lifetime Capital Gains Exemption ($750,000 in 2013) if you intend to sell a successful qualified farm or fishing property.
How to Calculate a Capital Gain or Loss
You need three pieces of information in order to calculate a gain or loss. The proceeds from the disposition (sale), the adjusted cost base (ACB), and expenses incurred to sell the asset. The ACB is calculated by the cost to acquire the asset, plus improvements, new purchases, sales, less expenses, etc. You then subtract the total ACB from the proceeds, resulting in either a capital gain or a capital loss. If it’s a positive amount, you then multiply your capital gain by the inclusion rate (50%) to determine your taxable capital gain. Vice versa for a negative amount.
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