So, you want to avoid capital gains tax. It’s hard — and, um, illegal — to avoid paying income tax entirely, so please don’t do it. We’ve seen enough celebrity oopsies to know better than that. But if you are wondering how to limit capital gains taxes (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. There is no specific “capital gains tax rate,” but instead, the taxable portion of capital gains is included in your total income, making it subject to your marginal tax rate.
Assuming you’re not acting on behalf of a corporation or trust, with capital gains tax, you’re charged tax on 50% of your gains up to $250,000, and then 66.67% for any gains beyond that (good job, you!). So if you had capital gains of $310,000 in a year, you would owe taxes on $165,000 of it. That’s 50% of the first $250,000 (so $125,000), plus 66.67% of remaining $60,000 (so $40,000).
Considering you would pay your full marginal rate on any additional employment income, that’s actually a good deal! Even if it doesn’t always feel like it. And of course, 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:
1. Put your earnings in a tax shelter
Tax shelters act like umbrellas that shield your investments. As long as they remain inside a tax shelter, your investments are left to flourish duty-free, which means you can buy and sell stocks at your leisure with no tax consequences. The one downside? You don’t get to write capital losses off your total income.
A Registered Retirement Savings Plan (RRSP) is a common account used to save and shelter gains from taxes. Any profit you make inside an RRSP isn’t taxed right away. It’s not until you withdraw money. It will be at your full marginal rate, but since most people make withdrawals during retirement, when their income is lower, their marginal rate is lower too.
A Tax-Free Savings Account (TFSA) works similarly to an RRSP in protecting against capital gains. The biggest difference is that the money you put in a TFSA has already been taxed, so when you withdraw it (along with any extra earnings), you’re not taxed at all. While the annual contribution limit has fluctuated between $5,000 and $10,000 since its inception, if you contribute about $6,000 each year (keeping in mind the annual contribution limits so you don’t get dinged with an over-contribution penalty) with after-tax dollars, and invest that money over 30-50 years, you could, hypothetically, see it grow to a significant sum, and that amount wouldn’t be taxed a cent when you withdrew it.
A Registered Education Savings Plan (RESP) is another tax shelter you can use to avoid capital gains tax. RESPs help you save for your child’s education. When it’s time for them to withdraw the money, your child will be taxed, but presumably at very low rate, since most kids aren’t exactly raking it in as students.
2. Offset capital losses
Let’s talk wins and losses. If, in the same year, you earn a $1,000 profit from selling ABC stock (fist bump!), but lose $1,000 when you sell XYZ stock (argh!), then your profit is effectively zero. The win and loss cancel each other out, and in that case, you won’t have to pay any capital gains tax.
But what if this wasn’t exactly your year and you have only losses to report? Here’s where the strategy comes in: you can carry your losses forward indefinitely or backward up to three years, applying them to different years to offset any gains you’d be taxed on. 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.
(One quick thing to note here: 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 will pick up on and doesn’t allow.)
There is, however, a rather clever way to work around this. It’s called “tax-loss harvesting,” in which 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 an exchange-traded fund. Therefore, you’re reducing your tax burden but still potentially capturing gains in a sector you’re confident will go up (although there are no guarantees).
3. Defer capital gains
This isn’t really a strategy, but you can defer paying capital gains tax for your shares when you got them from a spouse or common-law partner 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. A profit or loss is calculated from the value at the time your spouse 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. The rules for this are complex, so consult a qualified tax professional. There is no lifetime capital gains exemption for publicly traded stocks.
5. Donate your shares to charity
Need more incentive to do a good deed? Instead of donating cash to charity, you could consider donating your shares instead. It’s a tax-efficient way to score some karma points. 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. Instead of paying the full tax in year one, you could coordinate with your kids to spread that gain out over five years so your marginal tax rate drops to a lower bracket, allowing you to keep more money in your pocket. In order for this to work, the buyer has to actually spread out their payments to you over that time so kiss that lump sum goodbye. (This can also get a little risky: the buyer could default on their promise as the years go by.) However, if you’re transferring certain kinds of property, like a family farm, to your children or grandchildren, it may be possible to spread out the gain over 10 years.
7. Sell your home.
Under Canada’s tax laws, primary residences are exempt from capital gains taxes. This includes a residence where your spouse or common-law partner or your children resided for part of the year, even if you didn’t. A cottage or summer home can also be exempt, but not investment properties or rentals you own.
