Capital Gains tax occurs when you sell capital property for more than what you paid for it. In Canada, you are only taxed on 50% of your capital gain. For example, if you bought an investment for $25,000 and sold it for $75,000, you would have a capital gain of $50,000. You would then be taxed on 50% of the gain. In this instance, you would pay tax on $25,000. In Canada, there are some legitimate ways to avoid paying this tax: Tax shelters, Lifetime Capital Gains Exemption, Capital Losses, Deferring, and Charitable Giving.
What You Need to Know
- Tax Shelters
RRSPs and TFSAs are investment vehicles that are available to Canadians that allow investments to be bought and sold with no immediate tax implications:
Registered Retirement Savings Plans are popular tax sheltering accounts. Investments in these accounts grow tax free and you are not subject to capital gains on profits. When you withdraw your funds, you will be taxed at your marginal tax rate.
Tax Free Savings Accounts are like RRSPs in that they allow investments to grow tax free and you are not subject to capital gains tax on the profits you make. The key difference between TFSAs and RRSPs is that TFSAs hold after tax dollars. This means you can withdraw from the account without incurring tax penalties.
- Lifetime Capital Gains Exemption
The Lifetime Capital Gains Exemption is available to some small business owners in Canada. It allows them to avoid capital gains when they sell shares of their business, farming property, or fishing property. The CRA determines the exemption amount annually. The Lifetime Capital Gains Exemption amount is cumulative over your lifetime and can be used until the entire amount has been applied.
- Offset Capital Losses
Generally, if you had an allowable capital loss for the year, you can use it to offset any capital gain tax you have owing. This can reduce or eliminate the taxes you owe. There are a few considerations for employing this strategy:
- Losses have to be a real loss in the eyes of the CRA. Superficial losses will not be allowed to offset gains.
- You can carry your losses forward or backward to apply them to different tax years. Losses can be carried back 3 years and carried forward indefinitely. This means you can accumulate losses that can be used to offset gains in future years.
- Defer Your Earnings
A possible strategy is to defer your earnings on the sale of an asset because you only will owe tax on the earnings that you have received. For example, if you sell a property for $200,000 you could ask the buyer to stagger their payments over 4 years. Then you would receive $50,000 a year which would allow you to spread out your capital gain tax.
This strategy is known as the Capital Gain Reserve. There are a few things you need to keep in mind before using this strategy:
- The Capital Gains Reserve can be claimed up to 5 years.
- There is a 20% inclusion rate for each year. This means you must include at least 20% of the proceeds in your income each year for up to 5 years.
- There are some instances that the 5-year period can be extended to 10 years.
Consider donating shares of property to charities instead of cash. This method allows you to make a charitable donation, receive a tax credit based on the donation, and avoid tax on any profit. Win-win!
Avoiding or deferring Capital Gain Taxes should always be done with the guidance of a professional financial advisor and accountant to ensure all CRA guidelines are being carefully followed. If you would like to have a personal consultation, please contact Winnie at firstname.lastname@example.org for an appointment.