Have you made capital gain? That’s great news, because this influx of cash from selling your assets will improve your financial health. However, these benefits may be taxed. Here, I answer seven common questions.
1. What is capital gain?
Capital gain represents the profit you make when you sell, entrust, transfer or donate your property; typically, you must include this gain on your annual income tax return. Property includes chalets, land, business or rental material (both large and small-scale), as well as shares, bonds and mutual funds.
To reduce the tax impact and avoid nasty surprises due to capital gain, make sure you have a good understanding of the relevant rules and regulations.
2. How do you calculate capital gain on a building?
Calculating capital gain on a building is relatively simple. Take the transaction total, then subtract the initial cost, and subtract certain expenses you incurred while you owned the property. These are called “capital expenses” or “capital expenditures.”
For example, if you bought a chalet for $200,000 and sell it for $250,000, then you have $50,000 in capital gain. However, only 50% of this is taxable, so you will be taxed on about $25,000.
On the other hand, if you decide to gift this $200,000 chalet to your children, and its fair market value (FMV) is determined to be $240,000, you will be considered to have gained $40,000 in capital. You will still be taxed, even if you are donating the property rather than selling it. And if your children sell the chalet for $300,000, they will be taxed on the additional $60,000 of profit.
You can only avoid being taxed on capital gain if the transfer occurs between spouses or if the chalet is designated as a principal residence. However, you will still have to pay taxes on any profit you make when you sell your other home.
Can some of the fees be claimed?
Make sure to keep all documentation relating to the initial purchase (purchase price, renovation, home improvement, clearing, surveyor, evaluation or brokerage fees, etc.), as well as any documentation demonstrating the value of certain types of work that have been done (expansion, addition of a garage, new roof, etc.), plus the related charges (commissions, fees, etc.).
You could potentially claim these fees when calculating your capital gain and completing your income tax return.
3. What about capital gain on securities, bonds and mutual funds?
The same rules and tax rates apply if you make a profit after selling or withdrawing securities (such as shares), bonds and mutual fund investments. In this case, you will be taxed on the difference between the purchase price and the sale price, with some exceptions.
As for Canadian businesses with a capital dividend account (CDA), when capital gain is generated, the half that was not taxed could be used to increase the CDA balance and be given to shareholders, who won’t be taxed themselves. Getting a good handle on this strategy could pay off.
4. How do you calculate taxes on capital gain?
The tax rate varies depending on the situation and on different criteria, such as the province or territory in which you live and your annual income. For example, someone with a lower income who declares modest capital gain will pay less tax than the maximum allowable amount.
Let’s go back to the chalet that was bought for $200,000 and sold for $250,000, generating $50,000 in capital gain. In this example, you will be taxed on about $25,000 (meaning 50% of your capital gain), and according to your tax bracket, if your income puts you in a higher bracket.
A few things to remember:
- You will be taxed on the resulting capital gain, even in the case of donations.
- You will be taxed on 50% of your capital gain. This is often better than the dividend tax rate, which is variable and can be higher if it hasn’t been determined beforehand.
- In Canada, if you have taxable capital gain resulting from the sale of farming or fishing goods, you may be allowed a specific deduction on your capital gain.
- Revenu Québec and the Canada Revenue Agency provide detailed documentation on all the rules, exceptions and exemptions to take into account so you can make the most of your tax strategies.
5. What is capital loss?
In some situations, you may incur capital loss, like if you sell shares or real estate for less than their original purchase price. In such cases, you can subtract this loss from your taxable capital gain. However, it’s important to note that you can only use this reduction strategy to lower your profits from a capital gain. You cannot deduct your capital loss from your income to pay less tax.
6. When do you declare a capital gain or loss?
It is important to declare capital gain or loss during the calendar year in which the transaction occurred, even if you do not have to pay taxes.
7. How do you manage your capital gain?
Contacting a financial advisor, a tax expert, an accountant or a wealth manager could pay off if you plan on generating major capital gain and if you own investments with dividends. A specialist will be able to advise you on declaring capital loss or on selling declining stocks to compensate for gain at a strategic time. Or, if you don’t have a steady income, you could declare your gain during a year in which your income is lower, which would allow you to benefit from a lower tax rate.