In Canada, tax on capital gains is at a lower rate than tax on interest. You can take advantage of favourable capital gains tax rates (Canada)—and substantially cut your tax bill—by structuring your investments so that more of your income is in the form of capital gains.
You have to pay tax on capital gains, specifically on the profit you make from the sale of an asset. An asset can be a security, such as a stock or a bond, or a fixed asset, such as land, buildings, equipment or other possessions. However, you only pay tax on capital gains on a portion of your profit. The “capital gains inclusion rate” determines the size of this portion.
About 20 years ago, the Canadian government cut the capital gains inclusion rate from 75% to 66.6% and, within a few months, to 50%. This cut capital gains tax rates (Canada), and had the effect of lowering the overall rate you pay on capital gains to one-half of what you would pay on income or interest.
There are more ways to cut capital gains tax rates (Canada), though, such as:
Donating your shares to charity
Putting earnings in a tax shelter
There are more, but as we’ll review below, not all are sound strategies.
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How does tax on capital gains work?
Regards capital gains tax rates (Canada), if you buy stock for $1,000 and then sell that stock for $2,000, you have a $1,000 capital gain (not including brokerage commissions).
You would pay tax on capital gains at a rate of 50% of the capital gain amount.
This means that if you earn $1,000 in capital gains, and you are in the highest tax bracket in, say, Ontario (53.53%), you will pay $267.65 in capital gains tax on the $1,000 in gains.
In contrast, interest income is fully taxable, while dividend income is eligible for a dividend tax credit in Canada.
In the 53.53% tax bracket, you’d pay $535.30 in taxes on $1,000 in interest income, and you would pay $393.43 on $1,000 in dividend income.
What is tax-loss harvesting?
Tax-loss harvesting occurs when you deliberately sell a security at a loss in order to offset capital gains in Canada. You can then use these losses to offset your taxable capital gains. Not that doesn’t affect your capital gains tax rates (Canada), just the amount of taxable income.
Whenever you’re considering making use of tax-loss selling to minimize capital gains in Canada, you should also be aware of the “superficial loss rule.” This rule states that if an investor, their spouse or a company they control, buys back a stock or mutual fund within 30 days of selling it, then they are not permitted to claim the capital loss for tax purposes. Failing to obey the 30-day rule will result in the capital loss being disallowed.
Does making an adult child co-owner of your home or portfolio help with taxes or your capital gains tax rates (Canada)?
If you have capital gains on your portfolio, you are only liable for capital gains taxes when you sell. But if you put your son or daughter on as a co-owner, the Canada Revenue Agency could interpret that as a “deemed disposition”—a sale, in other words—of half the portfolio. That would leave you liable for capital gains tax this year, rather than deferring those gains until you sell or die.
When you die, you are deemed to have disposed of or sold your entire portfolio. But no matter how old you are, that day can still be years in the future. It’s a waste to pay capital gains tax any sooner than you have to. Worse, your stocks may have gone down by the time you die. The gain on which you’ve already paid taxes may have evaporated!
You won’t have this exact problem if you put an adult child on as co-owner of your home, since your principal residence experiences capital gains exemption. But each of us can only have one principal-residence capital-gains-tax exemption. If your adult child already owns a home, then any gains he or she makes on your home, after becoming joint owner, will be taxable.
In this case, putting your adult child on as co-owner of your home could convert some tax-free capital gains (in your hands) into taxable capital gains (in your child’s hands).
Are there any capital gains deductions?
Commissions and brokers’ fees aren’t the only expenses you can deduct when you sell your capital property. You can deduct many other outlays and expenses that you incur to sell your property, including fixing-up expenses, finder’s fees, surveyor’s fees, legal fees, transfer taxes, and advertising costs. To ensure that you claim all of the deductions you can, and do so correctly, we advise that you consult a knowledgeable tax professional.
Can you choose when to pay tax on capital gains?
One of the main advantages capital gains have over other forms of investment income is that you control when you pay tax on capital gains. This amounts to a very simple and highly effective way of deferring tax — and it’s perfectly legal.
You pay capital gains tax on a stock only when you sell, or “realize” the increase in the value of the stock over and above what you paid for it. In contrast, interest and dividend income are taxed in the year in which they are earned.
As an added bonus, if you sell after you retire, you may be in a lower tax bracket than you are when you are earlier in your investing career. In any event, the longer you hold onto a profitable stock and put off paying capital gains tax, the longer all of your money works for you.
This can have a significant impact on your long-term returns. To continue with the example above, if you buy stock for $1,000 and then sell that stock for $2,000, you will pay $267.65 in capital gains tax. That would leave you with $1,732.35 to reinvest (not including brokerage commissions).
However, if you hang onto the stock, you keep the full $2,000 working for you until you choose to sell. That holds out the potential for even further gains, and the possibility of paying less tax on your capital gains if you sell after you retire, when you may be in a lower tax bracket.
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I look at Canadian dividends being more attractive than capital gains on Canadian investments, I realize that the actual rate of tax is less from capital gain (50% of profit is taxable) however when looking at my investment transactions over the past 30 years, dividends win out when looking at money in my pocket. Why? The dividends come trickling in each year so the taxable amounts don’t generate that much tax. However, I have a larger amount in capital gains as I am selling the entire holding. There is no point in selling a bit each year because I am selling as the investment no longer appeals to me, so I get out completely.