Understanding Capital Gains Taxes in Canada
In Canada, capital gains taxes can quickly erode your wealth, making it one of the most important issues that must be dealt with in a wealth preservation strategy. While avoiding capital gains tax completely isn’t possible, there are still plenty of strategies that can be implemented to minimize the effects it has on your wealth.
How is the Capital Gain Tax Applied?
In Canada, 50% of any capital gains are taxed. The capital gains tax has a variety of wide-reaching effects; it can reduce the amount you receive through your investments, or reduce the amount of wealth you end up passing on to your heirs.
On a positive note, only realized capital gains are actually taxed. That means that the capital gains tax is only applied when you sell an asset; if your asset only increases in value on paper (an “unrealized” capital gain), you do not need to pay taxes on this gain.
How Can I Reduce the Capital Gains Tax I Pay?
Offset Your Capital Gains
When your capital gains are offset with a capital loss, you can reduce the amount of Canadian capital gains tax you pay. This can be done by selling your stocks, assets, or other investments at a loss. This also has the added benefit of allowing you to rid yourself of low-performing investments. However, keep in mind that the asset or investment must be sold at its fair market value; you cannot superficially undervalue the worth of the investment or asset.
Furthermore, the Canada Revenue Agency does not treat investors who create a superficial loss kindly. For example, you cannot sell a stock at a loss and then buy the stock back a few days later. You also cannot just sell your asset to your spouse. While there are some ways to work around this restriction, it’s best to work with an advisor who understands how to deal with superficial loss, and how to prevent it from affecting your overall wealth preservation strategy.
Carry Over Your Capital Gains Losses
This strategy can be implemented only if you have a capital loss in a given tax year. These capital losses can be carried forward to offset future capital gains. Since this loss can be carried over indefinitely, it can even be applied to your final return upon your death, decreasing the taxes paid by your estate.
Defer Your Earnings
Since you only owe taxes on the earnings you receive, you can lower the amount of Canadian capital gains taxes you pay by deferring your earnings. In this situation, you would sell your asset, but ask the buyer to stagger the payments made to you over a period of up to five years. With this strategy, you are effectively lowering your marginal tax rate since you are spreading your capital gains over a period of several years.
The time frame for deferring your earnings can be extended in some cases; if you have capital gains from giving qualified capital assets to your child, the time frame increases to 10 years. The assets, in this case, must come from a family farm, family fishing property, or a qualified small business corporation.
Use Tax-Advantaged Accounts
Registered accounts, such as TFSAs, RRSPs, and RESPs are all tax-advantaged accounts, meaning they protect your investments from taxes. Out of all of these options, RRSPs are the most popular in Canada. Any profits made in this account are entirely yours; however, funds withdrawn from this type of account are taxed at your full marginal rate. To avoid this, consider converting your RRSP into an RRIF.
TFSAs, by contrast, work similarly to an RRSP, but you can withdraw funds from this account without paying taxes. This is because the taxes were already paid on your contributions. If you plan on growing your wealth over an extended period of time, and want another tool that will allow you to avoid paying capital gains taxes in Canada, the TFSA is the way to go.
RESP are good for investors who are looking to save for the short term. Since they’ll likely be used to pay for your child’s education, you won’t be able to let your funds grow over an extended period of time. Your child will be taxed on the withdrawals that they make, but will likely pay a lower tax rate if their income remains low.
Donate To Charity
With this strategy, you would be donating a business asset to a registered charity, instead of donating cash. The assets donated in this case are usually shares within the business. When the donation is made to a registered charitable institution, you receive a tax receipt for the current fair market value of the share. The tax receipt can then be used to lower your income tax owing, without triggering a capital gain. This is because you are not selling the stock; you are merely transferring ownership of the stock.
Use the Lifetime Capital Gains Exemption
When a small business, farm property, or fishing property is sold, capital gains taxes will apply. However, the Canada Revenue Agency will allow you to use the Lifetime Capital Gains Exemption to reduce the tax burden you end up shouldering. This essentially shelters a portion of your capital gains from taxes. The deduction limit does get updated each year, so it’s best to check on current deduction limits.
Capital Gains Taxes in Canada May Rise in the Future
Recently, The Globe and Mail speculated that the capital gains tax rate may start to creep higher. Government spending has risen at an unprecedented rate and has ballooned the deficit to unsustainable levels. As a result, the possibility of the capital gains tax rate increasing is becoming more likely.
With this possibility on the horizon, it’s more important than ever to fully understand capital gains taxes in Canada, and how you can shield yourself from them. When you’re crafting a tax-efficient wealth preservation strategy, you’ll need to be able to keep up with these changes. The best way to keep yourself informed on the latest changes is by collaborating with experts.
The team at Global Solutions West is all about innovation, and keeping up with the latest tools you need to successfully implement your wealth preservation strategy. Our creative tax solutions won’t just address the needs you have today; they’re flexible enough to accommodate future changes in Canada’s tax landscape. Contact us today.