If you’re looking to sell property soon and are expecting to make some profit – congratulations! If you have owned a property for a few years there is a good chance that it’s worth more now than it did when you bought it and by selling, you can collect a nice amount of profit. However, you may have heard of something called the capital gains tax, which means you may not be getting quite as much as you thought out of the sale.
This tax applies to any capital property you sell for a profit, be it real estate, stocks, bonds or other assets. In real estate, the capital gains tax is a particularly hot topic because the high value of property means the effects of the tax are felt much harder.
It’s important to know about this tax before you start the process of selling your property. In this article, we will look at why the Canadian capital gains tax is in place, who is eligible to pay, how it is calculated, and how you can potentially minimize your payment amount.
The capital gains tax is an amount charged on monetary gains as a result of the sale of capital property. The Canada Revenue Agency defines capital property as "any property which, if sold, would result in a capital gain or a capital loss”, and something that is usually bought as an investment or to earn income. This includes investment properties, stocks, bonds, and land or equipment used by a business. It does not include traded assets of a business such as inventory.
Any capital property sold for more than the amount you paid would be considered a capital gain, whereas selling for less than the cost base would be considered a capital loss. In Canada, capital gains are taxed at the same marginal tax rate as your income, but only 50% of the value of your capital gain has tax applied.
These two taxes are somewhat similar, as you are paying a tax on money that you have received. The difference is that income tax is paid on money earned from things like employment, which are a more constant source of money. The reason that the capital gains tax differs is that the sale of capital property can be much more unpredictable and harder to calculate than standard income. It allows the government to still collect taxes on large capital gains while also allowing investors to minimize capital losses through deductions.
When it comes to real estate, the capital gains tax generally applies to any sale that is not your primary residence. You will be required to declare any taxable capital gain from your home sale in your tax documents when it comes time to file. Therefore, you should be sure to know how much you will owe and set it aside after the sale so you aren't surprised later trying to cover a huge tax amount.
In real estate, the most common exemption to the capital gains tax would be for a primary residence. Since your primary residence is seen as a home first and an investment second for tax purposes, you will not incur capital gains tax on the sale of your principal residence. A person may only have one principal residence at a time. In addition, you are only able to receive the full exemption if the property was your principal residence for the entire time you owned it.
If it was not your principal residence for a period during your ownership or a portion of the house was rented during the time you lived in it as a principal residence, you will still need to pay tax on a portion of the capital gain. For example, if you owned a home for ten years and it was only your principal residence for eight of those years, you would only be exempt on taxes for 80% of your gains while half of the remaining 20% would be taxed as income.
It’s good to know how the capital gains tax is calculated before you sell your home so you can anticipate how much you will be required to pay.
The first thing you need to know is that the capital gains inclusion rate is only 50%, meaning you only pay taxes on half of whatever you collect. For example, if you bought a house at $500,000 and sold at $700,000, only the difference is considered a capital gain ($200,000) and only half of that amount is actually taxed. That half will be taxed at the same rate as any other income you collect.
That's the simple explanation, but things can get a little more complicated when it comes time to actually calculate the real amount. For example, you don't simply use the sale price of the home, but rather what is called the adjusted cost base. This figure is the total amount of money that went into the property including the sale price, closing costs incurred in the sale, and any capital expenditures on the property.
Capital expenditure can be thought of as any major investment or improvement that adds value to the property like a major renovation and not regular expenditures like monthly utilities or small repairs. Furthermore, the costs of selling a home, such as agent commissions or legal fees, should be subtracted from the final capital gain amount.
Your income tax rate will be determined, as usual, by your net income amount for that year. This means the exact rates and amounts of capital gains tax will vary in each individual circumstance. Check online for capital gains tax calculators or speak to your accountant for the most accurate figures you can expect to pay.
If you sold a property for a capital loss, you will naturally not have to pay any money on the resulting payout. In fact, any capital losses may be used to offset taxable capital gains in the same year to a minimum of zero. Any additional capital losses can be retroactively applied to capital gains in the last three years or carried forward into future tax years.
Note that not every sale will be eligible for a capital loss deduction, for example, the sale of a principal residence.
If you bought a property as an investment asset, you obviously had the intention to get as much money out of it as possible. Paying capital gains tax can obviously disrupt those plans somewhat. However, there are ways that smart investors can reduce the impact of the capital gains tax on their home sales. While I would never recommend tax fraud of any sort, there are some legal options available to you.
Timing your real estate sale at the right time can help reduce your capital gains tax. For example, if you have a fluctuating income, selling in a year you know you will have a lower income can allow you to pay capital gains in a lower tax bracket.
If you have assets that would be considered capital losses if sold, you could consider offloading these at the same time as your real estate sale. This can allow you to offset your capital gains tax with the losses from other assets. Be careful, however, as attempting to claim superficial losses for the sake of deducting capital gains can get you flagged by the CRA.
You could also consider holding your mortgage or income from a property sale in your RRSP if you have room for it. This is not technically tax-free, but rather tax-deferred, but can be helpful if you are trying to quickly build retirement funds. This is easier to do with smaller capital assets like stocks but is still possible for real estate holdings.
There is a lifetime capital gains exemption that an individual may claim on eligible properties sold in their lifetime. This exemption applies primarily to people who hold qualified farming or fishing property as part of an active business. If they are eligible, they may claim up to $1,000,000 in deductions over their lifetime.
You also have the option of gifting property to a spouse or family member in order to reduce your taxes owed. For example, if you transfer capital property to a spouse who is in a lower tax bracket, they will pay a lower capital gains tax than you would have. You could also consider gifting capital assets that would be considered a loss to a family member. Gifts of capital property are taxed as if sold at fair market value, meaning you can claim the capital loss while keeping the property within your family.
Hopefully, you now understand a bit more about the Canadian capital gains tax and what it means for your property sale. As with any tax topic, the nuances of the capital gains tax can get quite complicated for each different scenario. If you do plan on selling a property, be sure to consult a tax professional to make sure you are getting the right information for your situation.
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