Capital gains explained!
What is capital gain?
A Capital Gain is a very specific type of income that is commonly generated and earned in Canada. There are many transactions that can give rise to a Capital Gain, but we will focus on the general idea for the purposes of this article.
A capital gain is typically triggered when the fair market value (FMV) of a ‘capital property’ has increased above its original cost (ACB) over time and is subsequently sold at the increased market value.
What are some common examples of capital property?
Common examples of ‘capital property’ are:
- Investments such as bonds, stocks, or mutual funds
- Land, buildings, equipment
Keep in mind, Capital Gains can also arise from the disposal of personal-use property, such as boats and cars. This is less common as the value of these items tends to go down over time.
How are capital gains treated for tax purposes?
The most common misconception about capital gains is how they are treated for tax purposes.
We often hear people trying to avoid capital gains because they think they are taxed at a higher rate. This is where we come in to save the day and share the truth – in most cases, capital gains are the most favorably treated type of income you could have!
What is the tax rate for capital gains?
A specific tax rate does not apply to capital gains. Instead, an individual will be taxed at their marginal rate (which bracket they are at, depending on other income they are reporting in that year) on the taxable portion of the gain.
This is the key – the taxable portion is only 50% of the overall gain!
Capital Gain Tax Example
Mary bought a cottage in 1998 for $100,000. In 2020 she decides to sell, at a current market value of $300,000. We have a total capital gain of $200,000 – of which she will only include $100,000 as a taxable capital gain. This is taxed at the rates applicable to her based on other income as usual.
What are capital losses?
Similarly, we can have capital losses, in the case where the market value dips below the original cost.
These capital losses can only be used to offset capital gains. You may be able to carry a capital loss back up to three years if you had reported gains in those years. If not carried back or used in the year of the loss, they can be carried forward indefinitely until there are gains to offset.
Losses on personal-use property are not allowed.
Joe bought shares in a publicly-traded company for $5,000. He needed to sell them for some cash, but the market value had decreased to $4,000, so he had to accept the loss when selling. This capital loss of $1,000 can be carried back or used against future gains ($1,000 total gain, $500 taxable).
What is a capital gain exemption?
This topic could be covered by a few articles on its own, but it is worth mentioning here.
Certain capital gains can be eligible for ‘tax-free’ treatment if eligible for the Lifetime Capital Gains Exemption (LCGE). It is available only to individuals, not corporations.
This LCGE can be applied to the sale of qualifying small business shares (a private corporation you own), or the sale of qualified farm or fishing property.
There are very specific criteria and limits, so if you have any questions about whether a gain might qualify, don’t hesitate to reach out to your friendly local accountant for more info.