Understanding the Capital Gains Tax and Inclusion Rate in Canada

In Canada, understanding how capital gains are taxed is crucial. Capital gains are a critical aspect of the Canadian tax system for those with assets that have experienced capital gain or loss. They affect individuals invested in real estate, stocks, mutual funds, bonds, or other assets. Many people need help with financial mistakes regarding capital gains tax situations. These decisions can affect your life after retirement both positively and negatively. Seeking out quality financial advice often means a better understanding of the capital gains tax and inclusion rate.

Below we explain capital gains, how it works, and the concept of the inclusion rate, which is another key aspect of determining the amount of tax owed.

What is the Capital Gains Tax?

Capital gains are the taxes paid on the profit earned when a capital asset is realized for more than its original purchase price. The difference between the sale price and the purchase price is the gain. In Canada, only a portion of the gain is subject to tax. The inclusion rate determines the portion subject to tax.

The Capital Gains Inclusion Rate

The inclusion rate is the percentage of the capital gain that is taxable. As of June 25th, 2024, the first $250,000 is subject to a 50% inclusion rate. Any capital gain exceeding $250,000 from June 25th, 2024, and beyond is subject to a 2/3rd or 66.67% inclusion rate. Any gain that is realized prior to June 25th, 2024, will be subject to a 50% inclusion rate regardless of the size of the gain.

How is Capital Gains Tax Calculated?

Below is a step-by-step breakdown of how to calculate the capital gains tax.

1. Determine the Capital Gain: Subtract the original purchase of the asset from the selling price. For example, if one bought a home for $250,000 and sold it for $550,000, the capital gain is $300,000.

2. Applying the Inclusion Rate: Multiply the capital gain by the inclusion rate for each bracket to find the taxable portion. On the first $250,000 of gain at a 50% inclusion rate, $125,000 will be added to the taxable income. The additional $50,000 gain will be included at a 2/3rd or 66,67% inclusion rate, leaving us with $33,335 that will be added to the taxable income. The total amount of gain included in the taxable income is $158,335.

3. Calculate the Tax Payable: The taxable portion of the gain is added to the taxable income at the marginal tax rate. For example, if the marginal tax rate is 35%, then one would pay $55,417.25 in tax on the $158,335 taxable gain.

Net Capital Losses

Capital losses occur when an asset is sold for less than its purchase price. These net capital losses can be used to offset capital gains. This will reduce the amount of taxable income one has each year. Net capital losses can be carried back for up to three years to offset gains in previous years, or the loss can be carried forward indefinitely to offset future gains.

It is important to note that net capital losses of previous years can still fully offset capital gains realized in a year with a different inclusion rate. A loss incurred under the previous inclusion rate (prior to June 25th, 2024) can be used to offset gains taxed under the new rate.

Exemptions and Special Cases

Some assets can be partially or fully exempt from capital gains tax. These exemptions are as follows:

1. Principal Residence Exemption: If you were to sell your primary residence, the capital gain is exempt from the capital gains tax under the principal residence exemption. This exemption only applies to the primary residence. A person can only claim one home as their primary residence each year. Each year the home is listed as a primary residence, the overall gain, which is equally split amongst all years of ownership, will be exempt from capital gains tax for all the years your home is the primary residence.

2. Selling Investments at a Loss: If your have capital gains and losses in a year, you can sell investments at a loss to help reduce capital gains tax in a given year. Losses can be claimed from previous years as they can be carried forward indefinitely to help reduce capital gains. This is more commonly referred to as tax-loss harvesting.

3. Tax-Deferred Accounts: Capital gains on investments held in tax-sheltered accounts such as Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Accounts (TFSA). These gains will not be subject to tax for the duration that they remain in the registered account. Withdrawals from a RRSP are taxed as regular income. TFSA withdrawals are typically tax-free, barring a few exceptions. To learn more about the TFSA exceptions, they can be found on the Government of Canada website.

4. Lifetime Capital Gains Exemption: The exemption is available for gains realized from selling qualified farms, fishing properties, and shares in small business corporations that qualify for the exemption. The exemption is limited to $1.25 million of eligible capital gains. Gains in excess of the $1.25 million threshold will be subject to tax.

5. Deemed Disposition: In certain cases, such as death or emigration, the Canada Revenue Agency (CRA) will assume you have sold the assets at fair market value. A deemed deposition will be prompted. This will require you to report capital gains along with paying the tax associated even if you haven't sold the asset, as it's based on the fair market value.

Capital Gains Tax for Corporations and Trusts

Corporations and trusts have the capital gains tax and inclusion rate applied differently then the tax is applied to personal gains. Corporations and most types of trusts must include two-thirds (66.67%) of all their capital gains as taxable income. All gains on corporations and trusts are taxed at a rate of two-thirds. Individuals cannot share their $250,00 annual threshold with corporations they own.   The two-thirds inclusion rate is applied uniformly across all corporations, regardless of its sector. This includes professional, holding, and operating corporations.

Stay Informed

Capital gain tax is an important aspect of our tax system to consider for anyone involved in investing within Canada. Being able to understand how the inclusion rate works, along with how to calculate gains and losses, can help you make more informed financial decisions. This can improve your tax situation. Understanding the capital gains tax and inclusion rate can positively affect life after retirement and reduce financial mistakes.

For the latest and most detailed information, please visit the Capital Gains Inclusion Rate webpage from the Government of Canada. This resource provides the newest updates, insight and explanations on how capital gains tax and inclusion rate is applied within Canada.

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