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If you've recently earned profit from selling an investment, you may be required to pay capital gains tax. In Canada, capital gains or losses are realized only when assets (such as stocks, bonds, precious metals, real estate, or other property) are sold and are subject to capital gains tax.
In this article, we will focus solely on gains realized through the sale of securities (most notably stocks). A good understanding of this form of taxation may help you formulate personalized tax saving strategies. While this article offers general guidance, it is not tax or investment advice. It is always in your best interest to work with a tax or investment professional who can offer personalized support.
What are Capital Gains?
If you sell an asset for more than you paid for it, the profit you earned is a capital gain.
To calculate capital gains, you first need to determine the asset’s adjusted cost base (ACB). The ACB is the price you paid for the asset, plus any commission or legal fees you incurred to acquire or sell it. Once you know what your ACB is, simply subtract it from the sale price and any remaining profit is your capital gain.
For example, if you bought an asset for $500, and paid $20 in commission fees, your ACB would be $520. If you later sold that asset for $1000, your capital gains would be $480 ($1000 minus $520).
Capital Gain vs. Capital Loss
Capital Gains are profits you make when you sell an asset for more than you paid for it i.e., it’s ACB. On the other hand, a capital loss occurs when you sell an asset for less than its ACB.
When filing your personal income tax return, the Federal and provincial taxation authorities, such as the Canada Revenue Agency (CRA), allow you to offset capital gains with capital losses, thus sheltering the capital gain from taxation. Take note that capital losses can be used to offset a capital gain in any of the 3 preceding years or in any future year (i.e., they do not expire).
What is Capital Gains Tax and how it is calculated?
You may have to pay tax on any capital gains that you earn outside of a tax-sheltered account. However, in Canada, you’re only taxed on a portion of your capital gains. The portion of capital gains subject to tax is called the capital gains inclusion rate.
Capital Gains Inclusion Rate
The inclusion rate in Canada is 50%. This means if you have a capital gain of $100, only $50 is taxable. However, as of June 25, 2024, the capital gains inclusion rate for capital gains over $250,000 is now 67%. You can learn more about it on the CRA site.
In Canada, the taxable capital gain must be reported as income on your tax return for the year the asset was sold.
For example, if you sold an asset for $2,000 that has an ACB of $1,000, the taxable income is $500 ($1,000 gain x 50% inclusion rate). The $500 will need to be added as taxable income and you'll be taxed at your marginal tax rate based on your tax bracket.
Lifetime Capital Gains Exemption (LCGE) Limit
An eligible individual is entitled to a cumulative lifetime capital gains exemption (LCGE) on net gains realized on the disposition of qualified property.
LCGE allows you to exclude a certain amount of capital gains from tax over your lifetime. This is particularly relevant for small business owners and farmers. For example, there is an exemption limit for qualified small business corporation shares and for qualified farm or fishing property. Please visit the CRA site to learn more.
Capital Gains vs. Interest and Dividend Income
It's important to understand how different types of investment income is calculated for income tax.
- Capital gains: In Canada, only 50% of the total capital gains is taxable. It is included in your annual taxable income and taxed at your marginal tax rate. Capital gains only apply when you sell an asset at a profit.
- Interest Income: The money earned in the form of interest on assets, such as bonds and GICs, is taxed at the same marginal tax rate as ordinary income. For example, $100 interest earned on a 1-year GIC must be included in your annual total income.
- Dividend Income: The money earned in the form of stock dividends is taxed at a lower tax rate than interest income. Canadian dividend-paying stocks may be eligible for the dividend tax credit. For eligibility and calculation, please visit CRA site.
Day trading and Capital Gains Tax
If you are day trading, and your income is primarily derived from capital gains, it may be treated as business income by the CRA. This would lead to it being fully taxed at your marginal tax rate instead of the 50% capital gain inclusion. The CRA classifies any income generated through day trading or active trading as business income.
Minimizing Capital Gains Tax
Here are a few ways to help reduce your capital gains tax burden in Canada
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Use tax-free or tax-sheltered accounts: A tax-free savings account (TFSA) can help you avoid capital gains tax. The income you earn in a TFSA, regardless of the type of income, is not taxable, even when the gain is realized. Funds withdrawn from a TFSA are also not taxable. The only exception is dividend income from U.S. corporations, which will generally be subject to U.S. withholding tax. Please note, TFSAs have a yearly contribution limit and exceeding your limit results in monthly taxation on the excess amount. Read: How to make the most of your TFSA contribution limit
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A registered retirement savings plan (RRSP) can also help reduce your tax burden. Capital gains earned on income in an RRSP are not taxable when the gain is realized but rather when the funds are withdrawn. These withdrawals are taxed at your marginal tax rate as ordinary income.
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Tax loss harvesting: In Canada, you can offset capital gains with capital losses. This reduces your overall tax burden and is known as tax loss harvesting. Lower-performing funds in a portfolio generate a capital loss that may be used to offset all or part of any realized capital gains. These capital losses can be used to offset any gains realized in the last three years or in any future year as they do not expire. Please note that capital gains inside registered accounts, such as an RRSP or TFSA, are tax exempt. The CRA does not allow the use of capital losses within registered accounts to offset gains in other accounts.
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Track expenses: It's a good idea to keep track of any qualifying expenses incurred in securing or maintaining investments (For example, management, legal or trading fees) as these expenses may increase the adjusted cost basis (ACB) of your investments. Capital gains tax is calculated when an asset is sold for more than its ACB.
Capital gain income is a sign that your investments are growing. Careful planning, however, is essential when it comes to getting the best tax benefit.
Frequently asked questions
What is the new capital gains rule in Canada?
Budget 2024 increased the capital gains inclusion rate from 50% to 67% on any capital gains earned by an individual over $250,000. These changes apply to any capital gains realized on or after June 25, 2024. In addition, individuals cannot share their $250,000 annual threshold with any corporations they own. While in most cases, corporations and most types of trusts must include two-thirds of all their capital gains as taxable income, there are some exemptions for specific assets or corporations.
How do I report capital gains and losses on my tax return?
Capital gains and losses can be reported on Schedule 3 of your annual tax return. You will need to provide certain details including the cost of the asset, what you sold it for, and any associated expenses.
What is the capital gains exemption in Canada as per budget 2024?
The lifetime capital gains exemption (LCGE) previously provided a lifetime exemption of up to $1,016,836 on capital gains earned from the sale of qualified farm and fishing property or qualified small business corporation shares. As a result of Budget 2024, the LCGE limit has been increased to $1.25 million for qualified capital gain dispositions occurring on or after June 25, 2024. The LCGE limit is indexed to inflation and will likely increase every year in accordance with increases to the Consumer Price Index.
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