Are you looking to get started with investing in Canada? Are you currently an investor who is looking to make the most of their profits?
If so, you should keep reading.
We're going to cover everything you need to know about capital gains and how to avoid capital gains tax in Canada. Understanding the tax laws can be difficult, but we break everything down here.
A capital gain is the amount of money that you make off of an investment. When it comes to real estate, a capital gain is the amount of money that you make off of buying a house and renting it out. Real estate is the most popular example, capital gains apply to any kind of investment.
You are considered to have made a capital gain on an investment if the asset that you own increased in value.
However, if your investment decreases in value or you sell the investment for less than you spent on it, this is a capital loss. These aren't necessarily bad, because capital losses can be used to offset capital gains.
By having some loss, you can offset the tax that you'd have to pay on your gains.
Capital gains can be short-term or long-term. A short-term capital gain is any investment that you own for less than a year, while a long-term capital gain is any investment that you own for more than a year.
Categorizing your investments is important when it comes to the capital gains tax.
The capital gains tax is a tax that the Canada Revenue Agency (CRA) places on capital gains.
There is realized and unrealized capital gain. Realized capital gain happens when you sell the investment for more than you bought it for. Unrealized capital gain happens when your investments have increased in value but you haven't sold the investment yet.
You are required to pay capital gains tax on a realized capital gain. That means that you only pay a tax on an investment that has increased in value if you sell it.
You shouldn't view the tax as inherently bad. Making money on your investment isn't a bad thing.
The capital gains tax is simply the way that the government accounts for income that doesn't come from a simple job or career.
We should note that investments into accounts like the Registered Retirement Plan (RRP), Registered Education Savings Plan (RESP), and Registered Retirement Savings Plan (RRSP) don't count towards the capital gains tax. Hopefully, these accounts are making you money over time. However, they are tax-sheltered.
"Tax-sheltered" means that any money that you're making in these accounts are safe from taxes.
While you're donating to these accounts, you're avoiding taxes and saving for retirement and school. What could be better?
In Canada, there is no individual tax rule for capital gains tax. Instead, the capital gains tax is recorded as a part of the Income Tax Act. In this clause, you'll find that the capital gains tax is considered to be an income tax payment on a portion of the capital gain that you make.
50% of the capital gains that you make in your investment endeavours are taxable. This means that you should add 50% of the capital gain to your other income that you're making once your capital gains tax is realized.
The amount of capital gains tax that you pay will depend on how much your investment grew, how much money you're making outside of that investment, and what other income sources you have.
If you have capital gains and capital losses to account for, you can offset the losses with the gains. This means that you can use your capital losses to decrease your taxes. In fact, if you have enough losses, you can offset the gains to zero.
If you only have capital losses in a given year, you can use them to offset gains that you had in the previous three years. Plus, you can carry that loss into the future indefinitely to offset any gains you may have in the future.
If you're confused about accounting for gains and losses, you should talk to your tax professional. Laws are always changing, so it's best to get their expertise when it comes to tax filing time anyways.
In order to calculate your capital gains, you need to first calculate your adjusted cost base. This tells you where your investment started.
The great thing is that most institutions calculate this for you. However, you may have to calculate it yourself if you have a self-directed account.
To calculate the adjust cost base, you need to add together the original purchase price of the investment as well as the cost of acquiring it. The cost to acquire the investment may include fees that you likely had to pay to take advantage of it.
For example, you might be looking to buy a house in Canada. With this purchase, you'll have several fees to account and pay for. These are included in your adjusted cost base.
Once you've calculated your adjusted cost base, you can subtract that value from the selling price of the investment. When you're thinking about your selling price, you need to think about the fees that are included in the selling process as well.
The difference between the buying price with fees and the selling price with fees is the capital gain (or loss). If there is a capital gain, you need to pay taxes. If there is a capital loss, you can use the loss to offset prior gains up to three years back or save the loss to offset gains in the future.
For some investments, like those involving real estate, you may also have expenses involved with keeping up with the investment. If you perform any kind of improvement on an investment like a house, this is not included in your capital gains. Therefore, you should subtract it from the taxable amount.
Note that maintenance costs are not included in this.
No one likes paying taxes. That's why we've also gathered some ways that you can get around paying the capital gains tax.
If you use these techniques that we've gathered, you're going to have a smaller amount of capital gains eligible for taxation. Therefore, you aren't going to owe as much in taxes.
Get your notepad out and get ready to implement these strategies come tax time.
Earlier, we mentioned how investments that are growing in registered accounts are sheltered from taxes. Paying into these accounts isn't a bad thing.
Just because you can't access the money whenever you want doesn't mean that you shouldn't utilize the fact that they help you make money over time. In fact, it might be better that you can't touch that money.
We encourage you to max out the contributions to registered accounts so that you can take advantage of the growth in your money later.
You'll be making money for yourself, but you won't be taxed on it.
As we mentioned before, you can use capital losses to offset any gains that you may make within a tax year. If you're purposefully collecting capital loss to offset those gains, this is known as tax-loss harvesting.
You should be very careful if you're looking to use this tactic. In fact, we recommend that you hire the help of an accountant to ensure that you're following all of the rules.
The CRA does not take kindly to superficial losses. These are losses that you hold for a few days
For example, you may sell a stock at lower than you bought it for so that you have a capital loss to set off a capital gain that you noted earlier. Then, after recording that loss, you may rebuy that stock or a stock that follows the same index a few days or even weeks later so that you don't actually lose that money
Because you didn't truly lose the money and made your taxes appear like you did lose the money, this is referred to as a superficial loss.
The CRA looks for these superficial losses and will not count them as capital losses if they suspect that you've done this purposefully. Plus, this may lead to an audit into your account in the future.
If you're planning on using your capital losses, we recommend consulting an accountant and being very careful when you're planning to count those losses.
If you want to be safe, make sure that you're only counting losses that you deem worthy to lose in order to pay fewer taxes. These kinds of losses are less likely to catch the CRAs attention. Plus, by keeping this in mind, you're less likely to get involved in strategies that fall into the grey area of the tax law.
If you're looking to avoid the capital gains tax, you can actually use the strategy of offsetting this tax with the Charitable Donation Tax Credit. This a tax credit that you can earn if you choose to donate money to any qualifying charity.
When you make a charitable donation, you'll receive a receipt for that donation. This is why it's so important to choose a charity that is considered legitimate by the CRA. These institutions are the only ones allowed to give out these receipts.
Make sure to keep any and all receipts that you get so that you can claim these donations on your taxes.
One of the best ways to make a charitable donation and receive the charitable donations tax credit while avoiding the capital gains tax is by transferring ownership of your investment. In Canada, you can transfer the ownership of an investment like a stock or a bond.
Because you aren't selling the stock or bond, you don't make a capital gain on it. Therefore, you don't have to pay the capital gains tax.
Plus, you'll get credit for the current fair market value of the stock. This amount goes towards your charitable donation tax credit.
You get to donate to a good cause, receive a tax credit, and avoid the capital gains tax all in one.
If you think that it would be best to save a capital loss for the future, you can carry them over indefinitely. Don't be afraid to save a capital loss to use more strategically later.
Plus, if you change your mind about applying a capital loss to a particular tax year, you can amend the capital loss onto your taxes for up to three years later. That means that you have three years to decide where you want to place a capital loss.
As you're strategizing as to where you should place your capital losses to receive the best value you can get, you should consult a tax expert.
Having a professional on your side is the best way that you can make sure that you're following the rules by getting all of the deductions, credits, and breaks that you can get.
Understanding how to avoid capital gains tax in Canada is important if you're looking to make the most of your real estate investing profits. We hope that our guide has helped you figure out everything you need to know about capital gains tax so that you can approach your taxes confidently.
Whenever you have more questions about finances, check out the rest of our blog. From taxes to insurance, we have everything you need to know about a variety of subjects.