When income is generated, tax often reduces the amount an investor eventually receives. Whether it is employment or interest income, dividends or capital gains, the Canada Revenue Agency (CRA) has specific rules, regulations and rates to subject income to tax. The 2024 federal budget has increased tax rates for capital gains, but tax advantages still exist.
What you need to Know
A capital gain is defined as an increase in the value of an asset. Capital gains come in two forms:
- A realized capital gain. When the value of an asset is higher when it is sold than when it was originally purchased. If a cottage with a cost of $250,000 is sold many years for $700,000, this transaction generates a realized capital gain of $450,000.
- An unrealized capital gain. This occurs when the value of the asset has increased, but it has not been sold. This is often referred to a “paper gain”. If an investor bought 1,000 shares of company for $75 each, and the stock is now trading on the stock market for $100 per share. Each share has an unrealized gain of $25, and the investor has an unrealized gain of $25,000 ($25 per share x 1,000 shares).
Once a capital gain is realized it is subject to taxation by the Canada Revenue Agency (CRA). A significant exemption from capital gains tax is a Canadian’s principal residence. For most Canadian tax-residents a capital gain from the sale of one’s home is not subject to tax.
Capital gains realized inside registered accounts, like RRSPs, RRIFs, RESPs and TFSAs are not subject to capital gains tax. Tax is triggered at withdrawal, and TFSA income and withdrawals are not taxed.
Additionally, a Lifetime Capital Gains Exemption (LCGE) exists for qualified small business corporation shares, and qualifying farm or fishing property. As of June 25, 2024, the limit is $1.25 million, and will be indexed to inflation beginning in 2026.
After exemptions, starting on June 25, 2024, one-half or two thirds of capital gains are subject to tax in Canada for individuals. The 2024 federal budget changed the inclusion rate. Simply, the inclusion rate is the amount of a capital gain that is subject to tax. For individuals, the first $250,000 of capital gains in a tax year are subject to the one-half inclusion rate. Above $250,000, the inclusion rate rises to two-thirds. The budget has increased the inclusion rate for businesses to two-thirds.
Example: A cottage with a cost of $250,000 and is sold many years later for $700,000. This transaction generates a realized capital gain of $450,000. Assuming the sale occurs after June 25, 2024, and no exemptions apply, one-half of the first $250,000, and two-thirds of the gain above $250,000 is taxable.
$250,000 x 50% inclusion rate = $125,000
$200,000 x 66.67% inclusion rate = $133,340
Taxable Capital Gain $258,340
The taxable capital gain, not the entire capital gain of $450,000 is subject to income tax.
Bottom Line
Major dispositions (or sales) of assets generating a realized capital gain will trigger a tax liability. An exemption may allow some, or all, of the gain to escape tax, but it is best to consult financial and legal professionals prior to a disposition to ensure all necessary conditions are in-place.
