One of the most famous property investment strategies in Canada is the “Buy and Hold” strategy. That means buying real estate properties and then holding on to them until the property increases in value.
Once it does, you sell your property and the profit on the value increases. But did you know that your income from that strategy is taxable? In this article, I’ll share with you what capital gains are, how to calculate capital gains, and how capital gains taxes are calculated on property sales in Canada.
What is a Capital Gain?
Investopedia defines capital gains as the rise of the value of an asset that gives it a higher worth than the purchase price. This concept can be applied to both real estate and paper assets.
However, there are concepts called “realized capital gains” and “unrealized capital gains.”
Realized capital gains refer to profits earned from selling an asset such as shares or real estate, while unrealized capital gains refer to profits that would be made if the asset was sold at its current market value. When an investor buys an asset at a certain price and later sells it at a higher price, the difference in value is his or her realized capital gain. The realized gain must be reported on taxes.
Unrealized capital gains, on the other hand, refer to the potential profit one can make if they bound the asset before selling it – since they won’t have actually made any profits they won’t need to pay any tax nor report these kinds of gains.
As an investor, you only profit from capital gains once you sell your properties. However, you have to know the laws of your area pertaining to capital gains and their taxation if you want to maximize the profits you make.
Do You Pay Capital Gains Tax on a Residence Real Estate Sale in Canada?
The short answer to this is yes. In Canada, capital gains earned from selling your residence are seen as taxable income and should be reported accordingly. However, the applicable tax rates are different per area.
What Is The Capital Gains Tax Rate in Canada?
The Canadian banking system posits that capital gains tax in Canada is assessed on 50% of realized capital gains. Depending on the income tax bracket a person is in, the capital gains tax rate can range from 0-50%. People in the highest income tax brackets can expect to incur higher taxation on their capital gains, especially those with significant trading accounts or high-frequency investments. The good news for individuals with lower income levels is that they may be eligible for almost full exemption from paying taxes on capital gains depending on the province they reside in. When calculating taxes on your capital gains, it’s important to account for how these new regulations, along with your income, will affect you and your investments.
Here are the 2023 federal tax brackets and the marginal capital gains tax rates in Canada according to Tax Tips CA:
|$0 – $53,359||7.50%|
|over $53,359 up to $106,717||10.25%|
|over $106,717 up to $165,430||13%|
|over $165,430 up to $235,675||14.66%|
How Capital Gain Tax is Calculated on Canadian Properties
In Canada, capital gains tax is calculated as follows:
Capital Gain = Proceeds of Sale – Adjusted Cost Base (ACB).
The Adjusted Cost Base (ACB) is the original cost of an asset plus any adjustments made to it such as legal fees.
Follow the steps below to learn how capital gains tax is calculated on your home sale:
- Calculate your capital gain, which is the difference between what you paid for the property (the ACB) and the amount you sold the property for.
- Determine the “taxable capital gain”, which is 50% of your capital gain.
- Determine your marginal tax rate and apply it to your taxable capital gain. (You can use the table above for reference.)
Now, let’s put together a scenario where you’re using this formula to calculate your capital gains tax after putting your home up for purchase:
Let’s say that you bought a property worth $100,000 3 years ago. You then decide to list the property for sale. In the 3 years of owning the residence, the value went up to $250,000. This means that when you sold the property, the total capital gains on the property would be:
$250,000 – $100,000 (the ACB) = $150,000 (total property capital gains)
Since your property is in Canada, 50% of the total capital gains profit is subject to tax. Therefore…
$150,000 x 50% = $75,000
The total taxable amount for this property is $75,000. Now, if the property is under your personal name, the $75,000 balance earned from selling the home is added to your overall income. It is then subject to the marginal tax rate and under the respective tax bracket depending on where you are living.
To make it easier for you to calculate tax on your capital gains, you can use this capital gains tax calculator, Simple Tax Calculator I found on the web. You can also call your accountant to help you compute how much tax you need to pay on your Canadian property.
Many Canadian homeowners are confused about capital gains tax when it comes to selling a home with a mortgage. Capital gains tax only applies to the amount of gain realized from the sale, not to the entire selling price of the home. Although mortgage debt is excluded from the calculation of capital gains tax, any fees associated with paying off the property’s mortgage may be taxable. Understanding these basic rules will help ensure homeowners maximize their returns when selling their home with a mortgage.
Are There Any Exceptions to the Capital Gains Tax Rule?
Yes, there are a few ways one can acquire capital gains exemption in Canada.
For example, if you sell the property that is your primary residence, Canadian regulations state that you may be exempt from paying capital gains tax on the sale. This exemption is commonly referred to as the principal residence deduction. It is important to note, however, that if you’ve lived in the property for less than a year and decide to sell it, you may be taxed on your capital gain income. The basic rule of thumb is that in order to be exempt from paying capital gains tax on your principal residence, the property would have to have been your home for at least one year.
To make it simpler, it all boils down to your intent in selling. If the Government of Canada sees that you’re doing this as a business or company, you could be taxed. But if you had moved in, had a family, and then sold the property because the space isn’t enough, you may be exempted.
Another example of how you may be exempt from paying capital gain tax in Canada is if you inherit an asset from someone who has passed away.
How Else Can I Avoid Paying Tax on My Capital Gain?
Apart from making use of the principal residence exemption, there are a few other ways that Canada allows you to avoid capital gains tax or limit capital gains:
Offset Capital Gains
If you’ve incurred capital losses (i.e., you’ve sold your property for less than the cost base), they can be used to offset capital gains on another property. For example, if you made a capital profit of $75,000 from the sale of Property A, but also incurred a loss of $50,000 in the sale of Property B; your net capital gain would drop to only $25,000. This means instead of paying taxes on the larger sum ($75K) You can save money and pay tax exclusively on the difference between your profit and loss ($25K).
Home Office Deduction
You are eligible for the home office deduction if you meet at least one of the following requirements:
- Your home is your principal place of business
- You use your home on a regular basis to conduct business with your clients or customers
Lifetime Capital Gains
In Canada, lifetime capital gains are the profits made from selling an asset that has increased in value over time. These types of gains can come from a variety of investments such as stocks or shares, bonds and real estate, for example. In order to be eligible for the lifetime capital gains exemption, certain criteria must be met. The LCGE allows people to not pay taxes on up to $800,000 of their income from these types of investments each year. To qualify, you must meet certain conditions including having owned the asset for at least one year prior to its sale and not having claimed any other type of tax shelter on it during that period. Additionally, you must have been living in Canada throughout the entire holding period and own no more than 10% shares or voting rights in a company if the investment is held through a corporation.
Registered Retirement Savings Plan
A Registered Retirement Savings Plan (RRSP) can help to bring down your return on investments. RRSP contributions are tax-deductible when investing in a qualified retirement plan. This means you are deferring taxes until you make withdrawals for retirement. Withdrawing money from an RRSP during retirement incurs little to no taxes as long as the withdrawal is made within the guidelines of the Canadian Revenue Agency. The funds remain sheltered from taxation until they are withdrawn at retirement, helping to significantly reduce or completely avoid capital gain taxes while also growing your savings. An installed advantage is that you can use any amount of the funds withdrawn from the account each year and enjoy more flexibility in controlling your taxable income in future years compared to other savings plans such as TFSAs, RESPs and other investment accounts.
Tax-free Savings Account
A Tax-free Savings Account (TFSA) offers a versatile way of saving money without incurring any capital gains. The fundamental idea is simple: you can contribute a certain amount each year to maximize your savings, and the profits that come from those contributions are not taxable upon withdrawal. What this means, is that you can keep all the earnings in your account and growth of your investments even when taken out later on – making a Tax-free Savings Account an ideal option for avoiding capital gains. With a Tax-free Savings Account, Canadians now have the opportunity to save substantially in a tax-free environment for their own retirement or investment goals.
What are the implications of not paying Canada capital gains tax?
By taking advantage of the above-mentioned exemptions, you may be able to avoid paying taxes on your profits from investments or selling properties. However, it’s important to note that failing to properly report and pay taxes on your capital gains when needed can lead to severe financial penalties. If you fail to pay capital gains tax on your property or other assets when it is due, the Canada Revenue Agency (CRA) may take legal action against you in order to collect the taxes owed. It is always best practice to speak with a qualified professional before making any decisions regarding your capital gain income & taxation matters.
When should I pay my capital gains tax on property in Canada?
In Canada, the rule is that you should pay taxes on your capital gains for your property and other assets on or before April 30th of the following year after selling an asset. Additionally, if you are self-employed and have made capital gains, you have to pay taxes on your capital gains by that same deadline via a T1 General personal income tax return. It is also important to note that paying any remaining tax due after the regular due date may incur penalties and interest. With that in mind, it’s always in your best interest to plan ahead so you don’t miss any deadlines
In summary, understanding the rules and regulations regarding capital gains tax in Canada is a key step to ensuring your financial security. Knowing which exemptions you may be eligible for can help to reduce or even get rid of some of the taxes due on any profits from investments or asset sales. Additionally, it’s important to remember that failing to properly report and pay capital gains taxes when needed can lead to severe consequences such as legal action by the CRA. Finally, always plan ahead so you don’t miss any deadlines – paying after April 30th will incur penalties and interest charges. With these tips in mind, you’ll be well-prepared to handle your taxation obligations with confidence!.
In addition to making use of a reliable tax calculator and/or consulting an accountant, we strongly suggest you seek an attorney to help you determine the right decision for you and your situation when it comes to selling your home and handling the capital gains tax that may come with it. This is a safer way to avoid penalties in the future.
If you want more in-depth information on this, here’s a free resource you can read this article on How To Calculate Tax Payable On The Sale Of Your Rental Properties. Also, here’s an in-depth guide on capital gains from Canada Revenue Agency.