Recently I got a lot of inquiries asking… “what should I do if I know a huge tax bill coming up?” You might have sold your cottage. You may have given up your stocks or cryptocurrency or sold your cottage, rental properties, or other assets.
You are happily enjoying your profit until you realize – with huge capital gain also comes a hefty tax bill. And by April, The CRA is ready to share your profit too. So, how do you calculate the capital gain tax? And what can we do to keep as much money as possible?
In this article, I want to share 6 strategies that can help you “How to avoid capital gains tax in Canada“, so you can save tens of thousands of dollars.
1. What is Capital Gains Tax?
The capital gains tax is a means for the Canada Revenue Agency to recoup money from investment profits. The CRA provides a significant incentive: just 50% of your capital gains are subject to tax. This is done to entice you to invest your funds into businesses and support the expansion of the economy. You only have to pay tax on $5 million of earnings, such as if you earned $1o million by selling shares in a specific stock.
The phrase “capital gains tax rate” is ambiguous. The taxable component of capital gains, however, is instead added to your overall income and is taxed at your marginal rate.
2. How High is Capital Gains Tax?
Let’s get started! Let’s first have a look at how high the capital gain tax is.
In Canada, If you make any profit on an investment, 50% of the growth will be considered capital gain – So say, if you bought your 2nd property at $500,000 10 years ago and now you sell it at 1.5 million dollars.
1 million will become your profit, and 50% which is 500k of that will be capital gain and considered as your income that year. And that pretty much pushes you to the highest tax bracket and depending on which province you are in~ you will need to pay give or take $250,000 to our Canadian government.
3. How to Avoid Capital Gains Tax in Canada?
There can be different ways to reduce Capital Gains Tax in Canada. But I will tell you the best 6 ways through which you can save a lot on Capital Gains Tax in Canada. They are listed below.
Paying 25% tax isn’t fun, so let’s have a look at the 6 strategies you can use to offset your capital gain tax. I will first introduce the easiest way then I will move to a more complex strategy.
As a disclaimer, this article is for information purposes. Whether any of the strategies fit you or not, PLEASE talk to a tax specialist or a financial advisor.
3.1. Your Timing
Yes, the first and the most effective strategy to offset capital gain tax is simply your timing.
If you sell a property or shares, time the sale as early as in the calendar year as possible. The best timing would be the first two months of the year because then you have time for the next 14 months until April of the next year to figure out the tax problem.
So for example, if you sold a property or shares in January 2021, you have time until April 2022 to figure out the whole tax situation. But if you were to do it in December 2021, you also have to pay the tax in April 2022 – which is significantly less time.
Plan accordingly and maximize the timing of your capital gain.
3.2. Leveraging Capital Loss
Leveraging capital loss is the next tactic to reduce significant capital gain tax.
This means that you use the loss to even out the capital gain. Here is an example: Let’s say in the year 2020 you earned $1,000 profit from selling stock A in a non-registered account. Now, usually, you’d have to pay 50% in capital gain tax. But let’s say in 2020 you also lost $1,000 off selling stock B In this scenario, the win and the lose cancel each other out and you won’t have to pay capital gain tax.
It’s also possible to offset a part of the capital gain tax. For example, if you have a capital gain of $1,000 and a loss of $500. So your profit is $500 – and assuming you are in the 50% tax bracket, which is 250, which is a lot more feasible.
If you have a year where you only have losses, you can carry those losses forward or backward to apply them to different years. Carrying it backward is possible for up to three years to offset any gains for a tax refund, or carry them forward indefinitely and accumulate them. In most cases, a capital loss can only be used to offset a capital gain.
But there are even some instances where you can claim your capital losses against other kinds of income, but you should consult a qualified accountant to discuss this strategy. Now, one important thing to keep in mind is that in order to properly offset capital losses it has to be a real loss.
This means you can’t just sell and repurchase stocks within a month. What’s more, you also can’t sell a stock and then tell your spouse to buy it. Those things are considered “superficial losses” and they aren’t suitable to offset a capital gain.
What some people do is sell investments that have decreased in value and then purchase a similar investment. All in all, the capital loss is a solid strategy to reduce the tax burden.
3.3. Leveraging Your RRSP
But what if I don’t have any capital loss in my years of investing?
Let’s have a look at strategy number 3 – which is leveraging your RRSP.
RRSP is one of the most popular tax shelter accounts in Canada. While the investment gain pushes your income to the next level, RRSP can help offset it by lowering your taxable income. For example, if you bought a place at 500,000 dollars a couple of years ago and you now sell it at 700,000.
So, the capital gain will be $100,000 (profit / 2). And if your RRSP happens to have a $100,000 room, then you can contribute that $100,000, and your tax will be even out. Keep in mind, however, that once you take money out from your RRSP you will be taxed at your full marginal rate – because you did not pay tax on your income when you contributed.
And the room will not be regenerated. Still, it’s a good strategy to distribute your capital gain. Because instead of paying all the taxes in one calendar year. Once you put it in RRSP and you can choose a longer period to slowly take the money back out.
That’s why most of the time, I recommended we should contribute to our RRSP but don’t max out our RRSP every year. you want to save some room for this capital gain scenario. My suggestion is to leave 30% room every year and carry it forward.
3.4. Investment Loan
The next thing you can do to offset capital gain tax is to do an investment loan.
Underline 22100 the carrying charge, It’s possible to use loans to deduct interest but there is a requirement: Your loan must be directly involved to produce income.
It can be interest, dividends, rent, or business income. There has to be a direct link between the loan and the use of the fund. So, for example, you take on a loan and use it to invest in paper assets that pay dividends. Then it becomes tax-deductible.
There are a few things to consider:
- You must use the borrowed funds to purchase a business or other property in order to generate income. Property income includes interest income, dividends, rents, and royalties. Employment income doesn’t count toward this.
- You must pay the interest during the year in which you are claiming the deduction. Keep in mind that only the year in which compound interest is actually paid is deductible.
- There must be a legal obligation to pay the interest.
And let’s talk about a couple of things that we need to pay attention to.
Even though the interest you borrow is 100% tax-deductible and there is no cap like the RRSP room. But in the end, this is still a borrow-to-invest strategy.
Meaning your returns needs to be bigger than the cost of borrowing. Say your interest payment is at 3%, then you want to aim for at least a 5% return for the investment. And depends on what loan you borrow, it might reflect on your credit report.
3.5. Flow-Through Shares
Now strategy 1 – 4 is relatively simple and require less capital to do it.
The following 2 ways require larger capital in order for the math to make sense and it’s more risk involved so be sure to talk to a specialist first.
Strategy number 5 to offset huge capital gain tax is flow-through shares. What exactly is that? Flow-Through Shares are a special issue of common shares where the tax deductions are issued to the original investors and then become regular common shares after the tax deduction is completed. Ok.
What the heck does that mean?
In a nutshell, certain sectors in Canada like mining, oil, and gas, or renewable energy sectors need funding to grow and develop, so the government wants to encourage investors to support and in exchange the government comes up with a tax incentive called the flow-through share.
When you buy flow-through shares, the company will provide you with a tax slip that enables you to deduct the entire purchase price from your year-end taxes.
Here is an example of what that could look like: For easy numbers, Let’s say that your annual income is $100,000. And if you invest $10,000 in ABC mining, you can write your income by $10,000 and now your income is $90,000 Let’s assume you are in the highest tax bracket and your tax would be about 50%. so you save $5,000 in tax by lowering $10,000 of taxable income.
Similar to an RRSP in this case. And wait! there is more, You can then sell the shares for $10,000 assuming your investment has neither increased nor decreased in value.
Yes, This will create another capital gain of $10k which is taxed by 50% on half of the profit – which is about $2,500. So you got $5,000 back from the government, but when you sell and pay a capital gain of $2500, you are still net $2500 positive.
Now, while this strategy is powerful, it also takes a lot of planning and a good understanding of the flow through shares, tax calculations, and a lot more. Also usually the money needs to stay in the company for at least 2 to 5 years and worst-case scenario if the company goes bankrupt, the money you invested will become zero. Whether you have done this before or not, please triple-check with your specialist.
3.6. Last Tip
Strategy Number-6. I am not sure if every province has this. But I know If you are in B.C. you can use this strategy to offset your capital gain tax.
In order to provide small firms with access to early-stage venture funding to aid in their development and growth, the small company venture capital tax credit promotes investors to invest in equity investments in British Columbia. On their investment in a venture capital corporation (VCC) or an eligible business corporation, B.C. investors are entitled to a 30% tax credit (EBC).
I am not going to talk about the difference between EBC and VCC in this article. For your information, as long as they are recognized by the BC government, you can find the list in their program.
Let’s talk about the features of this strategy, each individual can invest up to $400,000 annually and receive a 30% refundable tax credit. And the keyword is a tax credit, not tax write-off, meaning you can save $120,000 in tax and the credit can be carried forward for up to 4 years.
Sounds like a lot of money involve and a lot of tax implications. And it for sure does. And according to research, 50% of all small businesses fail in the first 5 years. And again your investments can potentially go to zero. If you really want to do this talk to a pro who can show you the ropes as there is a lot that can go wrong.
4. Bonus Capital Gain Reserve
Alright, here are my 6 strategies to offset capital gain taxes BUT WAIT! I want to throw a bonus on you!
Strategy no 7. Capital Gain Reserve This is actually recommended by an accountant friend of mine. He said this is a good strategy especially if you are selling a business or a property. If the proceeds of disposition from a sale of capital property are not all receivable in the year of the sale, CRA allows a taxpayer to defer a portion of the capital gain, within specified limits, until the year in which the proceeds become receivable.
For example: When you sell a property, you usually have to pay the tax bill in full. The payment may, however, be spread out over a period of time. For example, you may sell a property for $50,000 and receive $10,000 when you sell it and the remaining $40,000 over the next 4 years.
There are limitations and restrictions to this rule. The calculation of the reserve is not easy. To talk about this approach, you should speak with a licensed accountant.
So to sum it up, the 7 strategies you can use to offset capital gain tax are Timing, Capital loss RRSP, Investment Loans, Flow-through shares, Small business venture tax credits, and as a bonus, the Capital Gain Reserve.
Some of them are more complex than others and involve more risk. That’s why I recommend talking to your accountant or financial advisor ahead of time, for better planning and saving as much in tax as possible.
Frequently Asked Questions
Some of the most asked questions about the capital gains tax are discussed below:-
Q1. How much do Canadians pay on capital gains tax?
Canadians usually pay about 50 percent of capital gains tax.
Q2. What happens if you will not report Capital Gains tax?
You would have to pay the federal and provincial or territorial penalty. It can cost you a lot more than that.
Q3. What is the capital gain tax on $200,000?
It will be about 15 percent for the $200,000.
Q4. What is subject to capital gains tax in Canada?
You have a capital gain when you sell, or are considered to have sold capital for more than the total of its adjusted cost base and the outlays and the expenses incurred to sell the property.
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