Lisa MacColl is a writer, investor and former compliance consultant in the group retirement and individual wealth management fields. Lisa has written about personal finance for 14 years and currently writes about investing and investment providers for Wealthsimple. Lisa's past work has been published in Canadian Money Saver, Advisor’s Edge, CBC, and CreditCards.ca. She was a nominee for the 2015 Oktoberfest Women of the Year, Professional Category. Lisa holds an M.A. and B.A. from the Wilfrid Laurier University.
Before we dig into the weeds of capital gains in Canada, there's something you should know. This is general information on capital gains to give you a better understanding of how it works. Since everyone's situation is unique, this should not be taken as advice and you should always consult a tax professional to determine what works best in your specific situation.
What is a capital gain or capital loss?
In simple terms, a capital gain is an increase in the value of an investment (such as stocks or shares in a mutual fund or exchange traded fund) or real estate holding from the original purchase price. If the value of the asset increases, you have a capital gain and you need to pay tax on it. That might sound bad — but trust us, making money on your investments is never a bad thing.
Capital gains can be “realized” or “unrealized.” A realized capital gain occurs when you sell the investment or real estate for more than you purchased it for. An unrealized capital gain occurs when your investments increase in value, but you haven’t sold them. The good news is you only pay tax on realized capital gains. In other words, until you “lock in the gain” by selling the investment, it's only an increase on paper.
A capital loss occurs when the value of your investment or real estate holding decreases in value. If the current value of the investment or holding is less than the original purchase price, you have a capital loss. Capital losses can be used to offset capital gains and reduce the overall tax you will pay. You can carry capital losses back 3 years or forward into future years.
If you have investments in registered plans such as a Registered Retirement Savings Plan (RRSP), Registered Retirement Plan (RPP) or Registered Education Savings Plan (RESP), you don’t have to worry about capital gains and losses because the investments are tax-sheltered. That means your investments can grow and you don’t have to worry about changes in value until you withdraw the funds.
If you have non-registered investments, capital gains are something you'll absolutely need to know about.
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What is the capital gains tax rate in Canada?
Go rooting in the Income Tax Act and you'll struggle to find something called “capital gains tax”. That's because there's no special tax relating to gains you make from investments and real estate holdings. Instead, you pay the income tax on part of the gain that you make.
In Canada, 50% of the value of any capital gains are taxable. Should you sell the investments at a higher price than you paid (realized capital gain) — you'll need to add 50% of the capital gain to your income. This means the amount of additional tax you actually pay will vary depending on how much you're making and what other sources of income you have.
If you have both capital gains and capital losses, you can offset the capital gains with capital losses until you reach zero. If you only have capital losses, the CRA allows you to use the capital loss to offset a capital gain you originally declared in the previous 3 years, or you are allowed to carry forward the capital loss into the future. How far into the future, right now it's indefinitely, so don't lose the paperwork! That said, rules can change and so it's best to check with your tax professional before taking any action.
How to calculate tax on a capital gain
Before you calculate your capital gains, you're going to need figure out something called the adjusted cost base. The adjusted cost base is the starting point for determining if you have made or lost money on your investments. It sounds scarier than it is. Most financial institutions will track your capital gains and adjusted cost base for you so there might be no need for you to calculate it yourself. That said, if you have a self-directed account and need to calculate tax on a capital gain — start by calculating the adjusted cost base:
Adjusted cost base = Book value (the original purchase price of the investment), plus costs to acquire it, such as fees.
Once you've calculated the adjusted cost base, you can figure out the amount of money that is taxable:
Capital gain subject to tax = Selling price (net of fees) minus the adjusted cost base.
The difference between the selling price of your asset and the adjusted cost base is the sum of money that's taxable.
If you buy shares at different times in the same fund, you can have different ACBs, depending on the book value at the time of the transactions.
Sample calculation of tax on a capital gain
In the examples below we'll show you how to work out the tax on a capital gain. Remember, we start by calculating the adjusted cost base.
Adjusted cost base example:
For straightforward buys and sells, the adjusted cost base is the book value plus any commission that was paid to acquire the investment. For example, if you bought 100 shares of XYZ Company at a total cost of $500 and you paid $25 commission, your ACB would be $525, the price of the shares plus the commission ($500+$25).
Now let's say you buy more shares of XYZ Company, but the share price has increased. This time you buy 200 shares at a total cost of $1,400. You pay the same $25 commission. Your ACB for this transaction is $1,425 ($1,400+$25).
Your ACB is the basis for figuring out whether you made or lost money when you eventually sell those investments. but you have no way of knowing what shares in your pot had which ACB, so you will need to figure out the average ACB per share.
To get that, you add the ACBs together, and divide by the total number of shares you own.
Remember those shares in XYZ Company? You own 300 shares.
Add up the ACB for the 2 transactions, They cost you $525+$1,425=$1,950. So your ACB for your shares of XYZ Company is $1,950.
Now divide your total ACB by the number of shares you own. $1,950/300 shares =$6.50. So your ACB per share is $6.50. You need this to figure out if you made or lost money.
Capital gain example:
You've decided to sell some shares in XYZ Company. Let’s review: When you sell your investment or real estate for more than you purchased it for, you will have a capital gain. When you sell your investment for less than you paid for it, you will have a capital loss.
You decide to sell 200 shares of XYZ Company when they reach $20 per share. There is a $50 brokerage fee. 200 x $20=$4000-$50 fee =$3950. This is the market price or selling price.
To figure out if you made or lost money, you need to start with your ACB per share on your shares of XYZ Company. We calculated that as $6.50.
Multiply your ACB per share x number of shares sold to get your ACB on the transaction. 200 shares x $6.50 ACB per share=$1300.
Now, deduct the ACB from your sale price on those shares. Your sale price $3950- your ACB $1300=$2650. Since it’s more than your ACB, you have a capital gain.
The sale price minus your ACB is the capital gain that you'll need to pay tax on. In Canada, 50% of the value of any capital gains is taxable. In our example, you would have to include $1325 ($2650 x 50%) in your income. The amount of tax you'll pay depends on how much you're earning from other sources.
The good news is most financial institutions that hold your investments will track your ACB and any capital gains for you and send you a form that provides you with the information you need. You could receive a T3 “Statement of Trust Allocations and Designations” for capital gains you earn in a mutual fund or Exchange Traded Fund, or a T5008 Statement of Securities Transactions for shares that you sell through a brokerage. You report your capital gain in Schedule 3 of your T1 General Income Tax form, the form you complete to file your income tax.
Capital loss example:
Let's look at a not so nice example where there's a loss rather than a gain. Imagine you purchased 200 shares for $6.25 per share and sell them for $4 per share. You have to pay a $50 brokerage fee when you buy and sell the shares. This leads you to lose money — ouch!
You decide to sell 200 shares in XYZ Company, but they're only worth $4.00 now. There is a $50 brokerage fee. You multiply the number of shares by the price per share and take away the brokerage fee (200x$4.00= $800-$50 = $750.)
Remember your ACB per share is the basis of determining if you made or lost money. To calculate this you add the purchace price plus the brokerage fee (200x$6.25 = $1,250+$50 = $1,300)
Deduct the ACB from your sale price on those shares ($750-$1300= -$550). Because your sale price is less than your ACB, you have a capital loss of -$550.
Dealing with capital loss
You can use any capital losses to offset or reduce capital gains. And if you have more capital losses than you need to reduce your capital gain to zero, or if you only have capital losses, you are allowed to carry forward that capital loss into future years, OR, you can carry it back up to three previous years to amend a capital gain you declared. (you will need to amend your income tax return to do this and may wish to consult a tax professional for assistance.)
Dealing with a capital gain
The 50% of the capital gain that is taxable (less any offsetting capital losses), gets added to your income and is taxed at your marginal tax rate based on your level of income and province of residence as of December 31. The federal tax rates for 2020 can be found on the Canada Revenue Agency (CRA) website.
How to reduce or avoid capital gains in Canada
Use tax advantaged accounts
Capital gains receive the most preferential tax treatment of dividends, interest and capital gains, so it makes sense to hold investments such as stocks, shares and mutual funds in a non-registered account, and leave the higher-taxed items in a registered vehicle where they can grow tax-sheltered.
Engage in tax-loss harvesting
You have the ability to offset capital gains with capital losses which reduces your tax bill. Selling low-performing funds to generate a capital loss that offsets all or part of your capital gain makes good sense. That's why it is deserving of a fancy name like “tax loss harvesting”. Some investment platforms track the performance of your investments and sell off the poor performers for you. Barry Choi, founder of Money We Have warns when doing tax loss-harvesting you can't create a superficial loss.
"There aren't that many ways to reduce your capital gains, but one easy strategy is to claim them against any capital losses that you have for the year. That means you can't create a superficial loss by selling it for less than it's real value."
The CRA does not look favourably on investors who sell low performers at a loss, and then buy them back a few days later. This “superficial loss” applies to assets that CRA would consider “identical.” For example, you could not sell a low performing Exchange Traded Fund and purchase a different one that tracks the same index within 30 days before or after the sale. You couldn’t sell your shares of XYZ Company and buy them back 3 weeks later. If CRA deems your transaction a superficial loss, you will not be able to use it to offset the capital gains. (you may also set yourself up for more scrutiny or even an audit in the future.)
You can use capital losses to offset capital gains from the previous 3 tax years, and you can carry them forward indefinitely.
Donate assets to charity
When you make a donation to a registered charitable institution, you receive a tax receipt which allows you to deduct a portion of your donation from income tax owing. Instead of making a donation in cash, you can transfer ownership of stocks to the registered charity. (An “in Kind” transfer). It's a way of rebalancing your portfolio without triggering a capital gain because you are not selling the stock, you are simply transferring ownership. You will receive a tax receipt for the current fair market value (what the stocks would sell for as at the day of the transaction). Consult a tax professional before you do this so you follow the correct procedure.
Carry over losses to the next year
Remember capital losses offset capital gains. If you have both capital gains and capital losses in the same tax year, you must use them to offset the capital gain. However, if you only have a capital loss, or you don't have capital gains from the prior 3 years that you could amend and offset, you can carry those capital losses forward to offset future capital gains. You might need to consult a tax professional to follow the proper steps to do this.