Understanding Capital Gains

2017-05-04

It has been almost 50 years since the federal government introduced taxes on Capital Gains. Before 1972, all capital gains were tax-free. Capital Gains Tax (CGT) was introduced to provide replacement revenues to compensate for the abolition of taxes on inheritance, and to provide additional revenues to finance the growing cost of social security systems at that time. CGT was also supposed to contribute to a more fair and equitable system of taxation.

When the sale price of Capital Property (ie: real estate, stocks, etc.) is higher than the cost base, the result is a Capital Gain. The profit or Capital Gain is subject to tax at your marginal tax rate. However, the full profit is not taxable. The amount of your profit or Capital gain subject to tax is calculated by applying the Inclusion Rate.

The Inclusion Rate on Capital Gains has changed over the years and when CGT was introduced, it was 50%. So if you purchased 10 stocks at a cost of $100 each, your cost would be $1000. When you later sold them at $110 each, you generated $1100. The difference of $100 is the Capital Gain. With an inclusion rate of 50% applied to the $100 profit, only $50 of that profit would be subject to your marginal tax rate. If you marginal tax rate was 43%, you were on the hook for 43% of $50 = $21.50. After paying your capital gains tax, you would be left $78.50 in profit. Not bad.

But then in 1988, the inclusion rate increased to two-thirds; then went up to 75% in 1990. But in the year 2000, February, it was brought back to 66.67% and later that same year in October, it was reduced back to its original 50% and has remained there to present-day.
And what happened to the lifetime capital gains exemption? It no longer exists in its original form of $100K lifetime maximum. The exemption is now called a Capital Gains Deduction and applies to the gains on the sale of certain small business corporation shares as well as on the sale of qualified farm and fishing properties. The limit is in the area of $800K. Business owners operating as sole proprietors might consider rolling over their operations to a small business corporation, especially if future sale of the corporate shares is anticipated.

And what about the capital gains generated by the sale of your home? This is still in place and is now call the Principle Residence Exemption. Effective for the 2016 taxation year, Canadians are required to report the sale of a principal residence on their tax returns in order to claim the full principal residence exemption.

When the government starts talking about tax reform and any proposed changes involving Capital Gains, Exemptions, Deductions, Inclusion rates – these are the topics most likely to impact investors.