Danielle Kubes is a trained journalist and investor who has written about personal finance for the past six years. Her writing has been published in The Globe and Mail, National Post, MoneySense, Vice and RateHub.ca. Danielle writes about investing and personal finance for Wealthsimple. She has a Bachelor of Humanities from Carleton University and a Master of Journalism from Ryerson University.
It’s hard — and, um, illegal — to avoid paying income tax entirely, so please don’t do it. But if you are wondering how to limit capital gains taxes in Canada (the legal way), there are strategies you can use.
The capital gains tax is a way for the CRA to collect revenue on the profit you make from investments. In order to encourage you to invest your money into businesses and help grow the economy, the CRA offers a generous incentive: only half of your capital gains are taxable. If you made $10,000 through selling shares of a certain stock, for example, you only need to pay income tax on $5,000 of those earnings.
There is no specific “capital gains tax rate.” Instead, the taxable portion of capital gains is included in your total income and is subject to your marginal tax rate. But since you are taxed on only half of your gains, you’re effectively paying only half of that marginal rate on your investment income (as opposed to your full marginal rate on any additional employment income). And that’s a good deal! But it doesn’t mean your tax hit won’t still be significant.
That’s where these strategies come in. Through employing fully legal methods such as sheltering and offsetting, you can reduce your tax burden. Here's how to do it.
Six ways to avoid capital gains tax in Canada
1. Put your earnings in a tax shelter
Tax shelters act like umbrellas that shield your investments. As long as your investments remain inside a tax shelter, they are left to flourish duty-free. You can buy and sell stocks at your leisure with no tax consequences. (Of course, that also means you don’t get to write capital losses off your total income.)
An RRSP is one of the most popular tax shelters in Canada. Any profit you make inside an RRSP-registered account isn’t taxed as the profit is earned. When you withdraw money, you will be taxed at your full marginal rate because you did not pay tax on your income when you contributed.
A TFSA functions similarly to an RRSP in protecting against capital gains. The biggest difference is that you the money you put in an RRSP has already been taxed, so when you withdraw it (along with any extra earnings), you can do so tax-free. If you contribute about $6,000 annually with after-tax dollars, and invest that money over 30-50 years until it grows to $1 million (which is possible! and not even that far-fetched, given average returns), you can withdraw that $1 million completely tax-free.
An RESP is another tax-shelter in which you can avoid capital gains tax. Since you plan to use that money in a short-to-medium term horizon for your child’s education, you’ll likely want to invest in low- to medium-risk securities. Your child will pay tax on the withdrawals, but since their income is likely going to be very low while they’re students, the rate will be minimal. Just note that you’ll have to close down the account in the 35th year after you opened it.
2. Offset capital losses
If, in the same year, you earn a $1,000 profit from selling ABC stock, but lose $1,000 when you sell XYZ stock, then your profit is effectively zero — the win and loss cancel each other out. In that instance, you won’t have to pay any capital gains tax.
Or perhaps you earn a $1,000 profit but lose $500. You offset the loss against the gain for a total gain of just $500, $250 of which you must pay tax on at your marginal rate.
Or let’s say this is a year where you have only losses. If so, you can carry your losses forward or backward to apply them to different years. You can carry them backward up to three years to offset any gains for a tax refund or carry them forward indefinitely and accumulate them. There are even some instances where you can claim your capital losses against other kinds of income, but you should consult a qualified accountant to discuss this strategy.
(Note that in order to properly offset capital losses, you have to have a real loss—you can’t just sell a stock and quickly re-purchase it. You also can’t sell a stock and tell your spouse to buy it. That’s considered a “superficial loss,” which the CRA doesn’t allow.)
There is, however, a rather clever way to work around this. It’s called “tax-loss harvesting”: you purposely sell an investment that has decreased in value while purchasing a similar (but not identical) investment. Say you really believe in the cannabis sector (duuuuuuude). You bought shares in a cannabis company at $1,000 but those shares dropped to $500. You sell the stock, claim the $500 loss, and then immediately purchase a different cannabis stock or ETF. Therefore you’re reducing your tax burden but still potentially capturing gains in a sector you’re confident will go up.
3. Defer capital gains
You can defer paying capital gains tax for your shares only when you got them from a spouse or parent due to death or divorce. So if your spouse bought 100 shares of ABC stock and then transferred them to you in the divorce, neither of you will have to pay capital gains tax on it at that time. You owe capital gains tax only after you sell the shares. The profit or loss is calculated from the value at the time your spouse/parent purchased them, not when they gave them to you.
4. Take advantage of the lifetime capital gain exemption
The lifetime capital gains exemption applies to some small business owners when they sell private qualifying shares, and farm and fishery property. Shares that qualify are those in a company that actively operates in Canada and is owned by Canadians. Additionally, the taxpayer or a relative must have owned the shares for at least 24 months prior to the sale. In 2022, the lifetime exemption is $913,630. The rules for this are complex, so consult a qualified tax professional. There is no lifetime capital gains exemption for stocks.
5. Donate your shares to charity
Instead of donating cash to charity, why not donate your shares? It’s a tax-efficient way of doing good. Not only is the “profit” from the shares considered zero, but you actually get a donation tax credit based on the market value of the shares at that time.
6. Use capital gain reserve
It may be possible to spread the proceeds of a capital property sale over five years. Because Canada has a progressive tax system, we are taxed more for every additional dollar we make. Say you sell a capital property, like an investment condo, to your children for a profit of $250,000. Your marginal tax rate would be a full 43.41% in Ontario. But if you manage to spread that gain out over five years, for $50,000 per year, your marginal tax rate tops out at 20.05%, allowing you to keep more money in your pocket. Doing this means the buyer has to actually spread out their payments to you over that time, so you'll have some convincing to do, though, and there is a risk the buyer could default on their promise. It also may be possible to spread out the gain over 10 years if you’re transferring certain kinds of property, like a family farm, to your children or grandchildren.
The future of capital gains tax
Canada’s deficit has ballooned during the Covid-19 pandemic as the government has borrowed close to $225 billion to pay for emergency benefits. Many experts speculate that in order to pay back this enormous sum the government will begin to raise taxes. These experts think that the capital gains tax is ripe for targeting. The capital gains tax has always been fluid. It didn’t exist before 1972. It then rose to 50% until 1990, when it rose again to 75%. It’s only since 2000 that the inclusion rate dropped again to 50%. There’s little stopping the capital gains tax from rising again, especially if the government needs increased revenue to pay its debt.
Avoiding Capital Gains Tax FAQ
Capital gains are the increases in value of assets that you own, such as stocks and property. The government likes to consider a portion of this gain as income so that making money in this way doesn’t occur tax-free. In Canada, taxpayers are liable for paying income taxes on 50% of the value of their capital gains in a given year. This means that you must take half of whatever you made in capital gains, add that amount to your income, and then subject that total income amount to income tax. The tax rate applied to the taxable portion of your capital gains will vary depending on your income and tax situation.
In Canada, there are a variety of legal ways to avoid paying capital gains tax. As detailed in this article, six of them are to (1) put your earnings in a tax shelter; (2) offset capital losses; (3) defer capital gains; (4) take advantage of the lifetime capital gain exemption; (5) donate your shares to charity; and (6) use the capital gain reserve.
If you own and are planning to sell rental property in Canada, you have limited options for avoiding paying capital gains tax on 50% of the profit on the property. However, it can be advantageous to sell at a specific time. If it’s getting toward the end of a tax year when you decide to sell, consider postponing the sale until after the new year to push the capital gain recognition into the next tax year. Doing this can delay your tax payment, but if your income is variable, it can also serve to reduce the amount you pay in tax. If your income in the year the gains are recognized is lower than usual, you may pay a lower income tax rate and thus less tax on the capital gain. Another strategy is to match the sale of the property on which there is a gain with the sale of an asset on which you’ve taken a loss. If you sell these in the same tax year, the loss will cancel out some amount (or all) of the gain, reducing the amount on which you owe tax.
Rules about capital gain tax on a second property in Canada are the same as those that apply to any other asset. Whether the second property is a vacation house, a home in an alternate location, or an investment property, it isn’t considered your primary residence. This means that you cannot apply the principal residence exemption to its sale. This exemption says that you do not owe capital gains on the profit from the sale of your primary residence.
While it is difficult to avoid paying capital gains tax entirely in Canada, there a number of ways you may be able to reduce your tax burden on yourcapital gains. Putting your earnings in a tax sheltered account can allow you to avoid capital gains taxes altogether for that particular money for a given period of time. You can also offset capital gains with capital losses, though this is hard to do with an exactitude that will entirely wipe out your whole capital gains bill. Another way of eliminating capital gains tax is to donate your shares to charity. If the gains are accruing on a home you own, you can reduce the amount of capital gains tax on it when you sell it by listing it as your primary residence for as many years as possible.
The types of income on which you pay capital gains tax in Canada are income from shareholder dividends; income from the sale of stocks or property (except your principal residence); and income from gifts of capital if those gifts produce income. Income of all of these types is considered taxable to some extent at a given taxpayer’s income tax rate for the year in question.
There is no rule laid out by the CRA about exactly how long you must own your primary residence in order to take advantage of the principal residence exemption, which says that you don’t have to pay capital gains on the profit on your home as long as it is your primary residence. CRA rules just say you have to “ordinarily inhabit” the place for a “short period of time,” which seems open to interpretation.
The main way of avoiding paying capital gains tax on inherited property in Canada is to make that property into your primary residence. If the home was the primary residence of the person who passed it on to you, then you or the estate will not owe capital gains tax upon your taking possession. This is due to the primary residence exemption. However, if you then turn around and sell that property, you’ll be liable for capital gains tax on 50% of the gain.
The lifetime capital gains exemption is a rule that pertains to some small business owners. It provides an exemption up to a certain amount over their lifetime for the sale of private qualifying shares of businesses and of farm and fishery property. Qualifying shares are those in a private company that is in active operation and has majority Canadian ownership. To qualify for the exemption, the shares must have been owned by the taxpayer or by a relative of the taxpayer for at least 24 months prior to the sale. In 2022, the lifetime exemption is $913,630. The rules for this are complex, so consult a qualified tax professional. The lifetime capital gains exemption does not apply to stocks.
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