Capital Gains Tax Canada 2022

Last updated on May 15th, 2022 at 09:33 pm

Capital gains tax can be used to your advantage as a serious wealth-building tool in Canada. It comes down to this simple fact: earning capital gains is so much more desirable than earning income. In this article, I’ll explain precisely why capital gains are so advantageous and how you can use this knowledge to build wealth.

Understanding Capital Gains in Canada

Here are the basics to help you understand capital gains in Canada.

What are Capital Gains?

A capital gain occurs when you sell a capital property for a profit. Capital property can be anything from stocks, bonds, mutual funds, ETFs, rental properties, or even highly speculative investments like Bitcoin.

Capital gains on cryptocurrency in Canada.
Even cryptocurrency is subject to capital gains tax in Canada.

Expenses incurred to sell your capital property can often be deducted from your capital gain. These expenses may include lawyer fees, transfer taxes, trading fees, and more.

What are Capital Losses?

Capital losses occur when you sell a capital property for a loss. This can happen if the value of your investment falls and you need to sell it to recoup some of your capital. A capital loss can also occur if the expenses paid to make your investment were larger than your capital property’s increase in value.

Capital losses aren’t all bad, though, as they can be used to offset your capital gains from other investments. Capital losses can even be carried forward to reduce taxes owed on capital gains in future years or to reduce taxes owed on capital gains in any of the past three years.

Capital Gains Inclusion Rate

The capital gains inclusion rate refers to how much of a capital gain is taxable. In Canada, the capital gains inclusion rate is 50%.

There has been some desire from federal parties to increase the capital gains inclusion rate to 75% or higher. If this were to happen, the benefit of earning capital gains instead of income would be reduced.

Capital Gains in Canada

In Canada, capital gains are taxed very favourably, with only 50% of a capital gain being taxable.

To emphasize how favourable this is, consider a situation where you received a $1,000 capital gain. Since it’s a capital gain, only $500 of the $1,000 is subject to tax at your marginal rate. Had you received the $1,000 as income, the entire $1,000 would be taxable at your marginal rate.

The advantage of capital gains in Canada is clear. If you are able to earn much of your income in the form of capital gains, you will have a much smaller relative tax burden than those making a similar amount as regular income.

What is Adjusted Cost Base?

To fully understand capital gains, you must familiarize yourself with a key term: adjusted cost base. Adjusted cost base is simply the purchase price of your investment plus any costs to acquire it.

Adjusted cost base also includes capital expenditures. If we think about a rental property, renovations or other capital improvements can be included as part of the cost of the property.

What is the Tax Rate on Capital Gains in Canada?

The effective capital gains tax rate in Canada is 50% of your marginal tax rate. This is equivalent to 50% of your capital gain multiplied by your full marginal tax rate. For a Canadian earning $75,000 per year with a marginal tax rate of 30%, any capital gain they received would be taxed at 15%.

Canadians save 50% on capital gains tax!

However, it’s important to realize that capital gains can push you into higher tax brackets. For example, consider someone only $1,000 away from their next income tax bracket. Had they received a $5,000 capital gain, 50% of the capital gain would be added to their income, thus increasing their taxable income by $2,500. Since they were $1,000 away from the next income tax bracket, they would pay $1,000 multiplied by their current marginal tax rate and the remaining $1,500 at their next marginal tax rate. This means their tax owed on their capital gain was slightly more than 50% of their marginal tax rate before they received it.

How to Calculate Capital Gains Tax in Canada

To calculate your capital gains tax, you must first calculate the size of your capital gain. Calculating the size of your capital gain requires the following:

  • The adjusted cost base of your investment
  • The proceeds from selling
  • The expenses incurred to sell

This process starts with calculating the adjusted cost base of your investment.

To use a basic example, consider an investor who purchased shares of a company for $1,000 and sold them later for $1,500. This investor’s adjusted cost base is the price he paid ($1,000), less any trading commissions paid to make this investment. Let’s assume they paid $10 in commissions to purchase their investment, and so their adjusted cost base is $1,010.

Calculating capital gain.
Calculating capital gain.

Next, they must calculate their sale price. If they sold the shares for $1,500, and paid another $10 commission to make the sale, then the net proceeds from selling is $1,490. Subtracting their selling price from their adjusted cost basis gives them their capital gain: $490 ($1,490 – $1,010).

To calculate the capital gains tax owed on this investment, we multiply the capital gain by 50% and add that amount to the investor’s income. If they were in a 30% income tax bracket, and this gain wouldn’t push them into a higher income tax bracket, the entire tax owed would be $73.50 ($480 x 0.50 x 0.30).

Capital Gains on Stocks in Canada

Stocks, and other liquid assets like bonds and preferred shares, are all subject to capital gains tax in Canada. However, since the capital gains inclusion rate is only 50%, investing in stocks and other assets can be a great way to shelter wealth from tax.

Capital Gains on Stocks in Canada
Investing in stocks can be a tax-advantaged way to grow your net worth.

Since you only have a capital gain if you sell for a profit, you can let your stocks grow for years without paying capital gains tax. You can then sell off your stocks strategically, in lower-income years to reduce your total tax burden.

Capital Gains in TFSA

Investments held in a TFSA are not subject to capital gains tax. Dividends and interest are similarly not taxed in TFSA—it’s called a tax-free investment account, after all. That’s one of the reasons the TFSA is such a fantastic investment account: it lets you avoid tax on your investments completely.

Capital Gains in RRSP

Capital gains in an RRSP are not taxed. However, RRSPs must eventually be turned into a RRIF and drawn down, and any withdrawals made from your RRIF are taxed as income.

This unfortunately means that by investing in an RRSP, you are converting taxed advantaged capital gains into income. However, the benefits of using an RRSP are still huge, as your assets are allowed to grow tax-deferred, which mitigates losing out on the advantage of capital gains.

Capital Gains on Real Estate in Canada

Here’s what you must know about real estate and capital gains in Canada.

Capital Gains on your Principal Residence

Capital gains tax in Canada can be substantial when selling real estate. Luckily, when that piece of real estate is your primary residence, you can completely avoid tax on your capital gain. This is hugely advantageous and makes your home one of the best tax-sheltered accounts in Canada.

Capital Gains on your Principal Residence
Your principal residence is not subject to capital gains tax in Canada.

Although, you may be subject to some capital gains tax in special situations. Like if your home was not your principal residence for the entirety of the time that you owned it.

Capital Gains Tax on Rental Property

Rental properties and other real estate assets not deemed your principal residence are subject to capital gains tax if sold for a profit. Conversely, if you live somewhere where real estate has declined, you may be able to sell your real estate assets for a capital loss.

Luckily, there are plenty of selling expenses that can be deducted from the profit earned when selling a rental property (or commercial property, for that matter). Expenses like advertising, appraisal fees, attorney fees, realtor commissions, and other closing costs can be deducted.

How to Reduce Capital Gains Tax

The best way to avoid or reduce capital gains tax is to invest in tax-advantaged accounts like an RRSP or TFSA. Your principal residence can also be used to avoid tax since selling your principal residence is not subject to capital gains tax.

But there are a few other good strategies to reduce your capital gains tax. You can:

  • Donate assets to charity
  • Offset your capital gains with carried-forward capital losses
  • Offset your past capital gains with net capital losses
  • Use tax-loss harvesting to generate capital losses

At the end of the day, you shouldn’t be too upset if you occasionally have to pay capital gains tax. After all, capital gains are already taxed very favourably. You can also reduce your capital gains tax by being strategic when you sell. By incurring capital gains in a year when you’re earning less income, you can reduce the amount of capital gains tax you have to pay.

How to Use Capital Gains Tax to Build Wealth

The advantage of capital gains rests in the fact that the inclusion rate is only 50%. That means you are better off earning as much as you can in the form of capital gains than in the form of income.

One strategy to accomplish that is to take out an investment loan to buy equities. The interest from your investment loan can be deducted from your income, reducing your tax burden. Meanwhile, your stocks are able to grow without being subject to tax until you sell them and incur a capital gain.

Another way to use capital gains to your advantage is by accumulating assets for the long-term and only selling when you are in retirement or otherwise at a substantially lower income level. Doing so allows you to minimize your capital gains tax.

Thanks for Reading!

I hope this article has given you a clear understanding of capital gains tax in Canada. If you’re a DIY investor like me, understanding capital gains taxes can help you make better investment and portfolio decisions. As always, the intention of this post is to be informational. If you have specific tax questions, be sure to reach out to a registered tax professional.

Please consider checking out some of my other recent articles, including my post on the RRSP contribution limit and my article on the TFSA contribution limit

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