Have you in your life ever thought Why is it important to know, how capital gains get taxed in Canada? What is Capital gain tax in Canada?
Well, I think there are two main reasons the first is if you are buying and selling assets throughout the end of the year and you have a gain by the end of the year the tax man is coming for you. It’s really good to know approximately how much this tax bill is going to be at the end of the year before you get it.
So, that way instead of spending all your profits on horses and blowing you can have the money ready when the tax bill comes.
The second reason is that you can actually see how much more efficient and effective investment income is in comparison to working income when it comes down to taxes and how much more money you actually get to keep off your investment income.
It can be a really good motivator for you to keep investing because you can actually see a tangible difference at the end of the year when it comes to your tax bill.
1. What is Capital Gains Tax in Canada?
When you buy an asset and you sell it for a profit within that tax year that is considered a capital gain and you need to pay tax on that profit.
And that asset could be a stock, an ETF, a mutual fund, a cryptocurrency, or even a piece of real estate. So, once you’ve sold that asset then that triggers a taxable event, and whatever profit you’ve made on the sale you have to pay tax on.
And you might be thinking “oh that’s lame I have to pay the tax, that sucks” and the fact that you’re even reading this article and you’re wondering about the tax on capital gains means you are farther ahead than the majority of people.
So, think about it that way you know if you’re having to start to think about taxes and think about taxes on investment income you’re probably doing pretty well. There are a lot of benefits to investment income too as we’re going to talk about soon.
2. Realized vs Unrealized Capital Gains
If you own a commodity that has increased in value but hasn’t been sold yet, you have an unrealized capital gain. So, the fact that you haven’t sold it yet means this gain is on paper only you’ll often hear it called a paper gain or it’s just theoretical.
If in theory, you were to sell this asset you would be you would have a profit and you would make money but you haven’t actually sold it yet. So, the fact that you haven’t sold it and you’re still holding means it’s an unrealized capital gain and this triggers no taxable event.
You do not pay any tax on this at the end of the year even if the stock that you’re holding has gone up a million percent. If you haven’t sold it you pay no tax.
A realized capital gain is when you’ve taken that asset and actually sold it to materialize the gain and you now have created actual dollars that you can physically take and go spend on something else. The act of selling triggers the taxable event that’s a taxable capital gain and you will have to pay tax on it at the end of the year.
3. How Capital Gains are Taxed in Canada?
Now, this is a way where we really differ from our American neighbors.
They have short-term and long-term capital gains tax depending on how long you’ve held the asset, we do not have that. We have a single, flat solution that we can use to figure out capital gains tax.
And that here in Canada we pay tax on 50 percent of the capital gain at our marginal tax rate.
So, what does that mean?
Basically when you go ahead and sell an asset for a profit fifty percent of the profit is tax-free and fifty percent of the profit gets added to your income at the end of the year and taxed at your normal rate.
For example, if you make a hundred thousand dollars a year at your job and you made ten thousand dollars in capital gains that year divide ten thousand by two five thousand of that is free income free profit whatever you wanna call it and five thousand of that ten thousand gets added on to your income at the end of the year.
So, at the end of the year, your total income on your tax bill would be a hundred and five thousand, a hundred thousand from working, and half of that ten thousand dollar capital gain.
How much you actually pay in tax on that fifty percent of the gain depends on two things one is which province you live in because the provinces have different tax rates. The second factor is your effective tax rate, which refers to your annual income.
If you are earning more in general income, working income, or whatever your income sources are your marginal tax rate is going to be higher than someone who earns less. So, everybody is going to have a different marginal tax rate and we’re going to talk about that in a little bit.
4. Easy 3-Step Formula for Figuring Out Your Net vs. Tax
There are three steps in order to calculate tax on your capital gain.
4.1 Step1:- Calculate Your Adjusted Cost Base
The first step is to figure out something called your adjusted cost base. And this is a fancy term that basically says how much did you pay for the asset originally. So, your adjusted cost base is your book value plus any commission fees incurred to obtain that asset.
Book value means what you originally paid for the asset, if you bought stock and you paid five thousand dollars total for stock all the stock shares, and ten dollars for your commission fees that would be five thousand plus ten and that would be five thousand and ten dollars is your adjusted cost base.
4.2 Step2:- Calculate Your Capital Gain
The second step is to calculate your capital gain. As a result, your capital gain is equal to your selling price less your adjusted cost basis.
Let’s say your selling price was six thousand dollars and your adjusted cost base was five thousand and ten dollars, your capital gain would be just shy of five thousand dollars.
4.3 Step3:- Figure Out Your Marginal Tax Rate
The third step is to figure out what your marginal tax rate is on your capital gain based on your province and your income and then apply that to your capital gain.
4.4 How Does All of This Work?
Let’s walk through an illustration of how this all functions.
Let’s say you live in Ontario and you make a hundred thousand dollars every annually year in income. In 2019 you bought stock for 990 dollars and you paid ten dollars in commission fees to acquire that stock.
And now it’s 2023 and you’ve gone ahead and sold that stock for ten thousand dollars. It’s gone up a lot and you want to cash out and take your game. So, your adjusted cost base is the 990 dollars you paid for the stock plus the 10 commission fee incurred to acquire the stock and that’s a total adjusted cost base of a thousand dollars.
To calculate your capital gain which is step two, you subtract your adjusted cost base from your uh selling price, so ten thousand dollars minus a thousand is nine thousand dollars for a capital gain. The next thing you have to do is figure out your marginal tax rate based on your province and your income level.
For Somebody living in Ontario who has an income of a hundred thousand dollars, the capital gains tax rate for this person would be 21.7 percent. Now, this is something really important that I think is a source of error a lot of times and it can be a little bit confusing that 21.7 percent applies to the whole gain.
I know we were talking about earlier that we pay tax on 50 percent but it applies to the entire gain and I honestly feel like the people who created these rules were like how can we make this as confusing as possible, so people just are so confused. They have no idea how to calculate this and then they just keep working the rest of their life and never invest.
If you imagine your full marginal tax rate paid on 50 percent of the gain is equivalent to paying half of the tax rate on the entire gain so that’s how they look at it.
Ontario person would be paying 43 percent on other income at that 100, 000 dollars income level. So, 43 percent or whatever it is there applies to 50 percent of the gain is the same as 21 percent applied to the entire gain. That’s the rationale for the tax on 50 percent of the gain.
What it really is is you pay half the tax on the whole gain but the way they talk about it is you pay the full tax on half the gain.
Understand it? Have I misplaced you?
It’s like super confusing but hopefully, I’m making it a little bit clearer here. To calculate now the tax on that nine thousand dollars you take nine thousand and multiply it by your personal tax rate for capital gains of 21.7 percent and you must pay tax on that income totaling $53 dollars at the end of the year.
This means you get to keep about seven thousand and forty-seven dollars in profit and you can take that profit.
5. How do Capital Gains Compare to Working Income?
A way you can compare this tax rate is to say well.
What if that person who’s earning a hundred thousand dollars a year made an extra nine thousand dollars at their job that year? So, let’s say instead of making a hundred thousand working you made a hundred and nine thousand so the tax rate would be different here.
You will have a different rate of percentage for taxation. It will be about forty-three percent so you would be paying thirty-nine hundred dollars in tax on that nine thousand dollar of extra working income and you would be left with about five thousand dollars left over instead of seven.
So, that’s a two thousand dollar difference in what you get to keep when it’s generated from capital gains and I think that’s pretty significant considering we’re only talking about nine thousand dollars here. Two out of nine that’s a fairly high percentage and that’s what I was talking about earlier in the article when you see how much more efficient investment income is it becomes such a motivator to acquire more income in this way.
Because it’s just better like it’s just better.
6. Capital Losses + Tax Loss Harvesting
So, that was just an example thereof one single capital gain but what if you’ve had many different transactions throughout the year and you’ve had many different gains? You made a thousand dollars here, two thousand dollars there, five hundred dollars here well it’s really easy you apply the same three-step formula and you just add up all your gains together and do exactly what we just did.
There’s really no difference there other than just adding all the gains together.
But what if you’ve lost money?
This is called a capital loss and this is when you sell an investment or an asset for less money than you originally paid for it. Now losing money is never fun but there are certain advantages that you can use to make the loss a little bit less painful. This is called tax loss harvesting.
At the end of the year, you add up all your capital gains so the stocks or investments you’ve sold for profit and you add up all your losses and you subtract them from each other to see whether you have a capital gain for the year or a capital loss.
There are really three scenarios that are possible.
6.1 Scenario 1
Scenario one is you are net positive. So, you have a net capital gain at the end of the year and you have to pay tax on that.
6.2 Scenario 2
scenario two is, that your net neutral gains exactly cancel out your losses and you pay no tax because you’re net zero.
6.3 Scenario 3
And scenario three is that your losses are greater than your gains in which case you can keep those losses and use them against future gains to reduce your tax bill in the future. Or you can actually take those losses and go back up to three years and apply them to previous gains in previous years to reduce your tax bill that way.
This is a little perplexing. I really wouldn’t advise doing this by yourself. You should probably consult an accountant about this.
But those are the three real scenarios of how you can end up at the end of the year when it comes to capital gains and losses and if there’s a benefit of losses, nobody likes losing money but if there’s a benefit it’s that you can use those losses to offset the gains. So, if you make a thousand dollars in a gain and you make a thousand dollars in a lot or you lose a thousand dollars in a loss at the end of the year, you are net zero so you pay no tax on any of your investments.
So, they kind of work against each other but losses you can carry forward a few years and up to three years back to apply them to any future gains. That’s one benefit I guess you can think about of losing money.
7. How Can Capital Gains Taxation be Reduced?
So, now one thing comes to mind, how can you reduce your tax bill on capital gains?
Well, there are three main methods.
The first method is tax loss harvesting, which involves using your capital losses to reduce your capital profits. The second way is to invest within your tax-advantaged accounts so your TFSA and RRSP. In these accounts, you can buy and sell assets within reason without triggering a taxable event. The RRSP eventually you have to pay tax when you withdraw but while the money is still in the account you don’t pay tax at the end of the year.
Pay capital gains tax, capital gains income tax capital gains taxes avoid capital gains tax offset capital gains realized capital gains registered retirement savings plan taxable capital gains tax-free savings account.
And the third way to reduce your tax bill on capital gains is don’t sell remember you only pay tax once the gain is realized. So, if you’re holding a stock and you plan for it to be a long-term hold it doesn’t matter how much it’s gone up if you’re still holding it, it doesn’t matter how much gain you have in theory on paper you pay no tax on that. So, one way to ensure you never pay a capital gain is to never sell.
This was all about capital gains tax in Canada. I hope you now fully understand the capital gains tax. You can reduce your capital gains tax by following the ways that have been listed in the article and can eventually save some money. The article mentions three different approaches. You can also calculate your capital gains tax by just some factors and have your own capital gains tax.
Frequently Asked Questions:-
Some of the most searched questions on google related to capital gains tax are listed below:-
Q1. What occurs if capital gains tax is not paid?
If you don’t disclose the income or capital gain, you could be subject to interest charges on the tax debt as well as penalties that could be greater than the tax debt’s interest charges. The penalties also rise if you are purposefully fake or delete info on one return for any more than a tax year, as your pals have done.
Q2. Do all capital profits have a 20% tax rate?
For long-term gains, the capital gains tax rates vary from 0% to 20%, and for short-term gains, they range from 10% to 37%. Only when an asset or investment is transferred are capital gains taxes payable. Short-term or long-term capital gains can be categorized based on how long you retain an asset.
Q3. How much financial gain is exempt from tax?
If an individual’s taxable revenue is $44,625 or less in 2023, they won’t owe any capital gains tax. If their revenue ranges from $44,626 to $492,300, the capital gains rate increases to 15%. The rate increases to 20% above that income threshold.
Q4. Does 15% or 20% capital gains tax apply?
It has to be paid during the tax year in which the asset is transferred. The long-term capital gain tax rates appear to be 0%, 15%, or 20% of the profit for the 2022 and 2023 taxable years, depending on the filer’s income. 1 The pay scales are adjusted yearly.
Q5. Are capital profits of 50% taxed?
A capital gain or loss is typically the discrepancy between the selling proceeds after deducting costs and the original cost of the asset. 50% of the gain is taxable capital gain, and 50% of the loss is permitted capital loss. Only taxable capital profits may be offset by allowable capital losses.