A lot of people have been asking me questions about capital gains, the taxes on them, and how to avoid them.
A lot of the questions suggest we need a refresher. So, let's review what causes tax on capital gains, how to mitigate these, and how you may be able to avoid them completely at times.
The Canada Revenue Agency (CRA) defines capital property in a fairly unhelpful fashion as "any property the sale of which, if sold, would result in a capital gain or a capital loss."
For more clarity, capital property includes shares or stock of corporations, units of mutual funds, bonds, debentures, or similar securities. Shares can include ownership of a private company or shares purchased on the stock market.
Capital property also means real estate, including land and buildings used as a recreational property, land, buildings and equipment used in a business, including a farm, and your own house.
Special exemption rules apply to a family's principal residence, and the gain is usually tax-exempt. Taxpayers can choose to apply the principal residence exemption to any one property that they (or spouse, former spouse or a child) lived in at some time during the year of disposition. (Go to www.davidchristianson.com/?p1180 .)
Special exemption rules also apply to farm property, farm corporations and shares of Qualified Small Business Corporations. Get good advice long before you think of selling, if you own such properties.
What constitutes a disposition? Typically, it is the actual sale of the capital property, like selling shares or real estate, or redeeming mutual funds.
If the net proceeds of sale (after commissions and other direct costs) exceed the adjusted cost base (ACB) of the capital property, then there is a capital gain, equal to the difference. If the proceeds are less, then there is a capital loss.
Here's the good news -- only half the capital gain is included in income. (You already caught on to the other advantage of owning capital property -- no tax is payable on growth in value until the item is sold.)
Capital losses can be used to offset gains in that year, but are not deductible against regular income. If you have more capital losses than gains in a year, the net capital losses incurred in that year can be carried back to offset gains claimed in the previous three years, or carried forward indefinitely, to offset future capital gains.
Caution: Certain other actions can also trigger a deemed disposition. For example, if you move into a property that you were previously renting out, then this "change of use" triggers a disposition, and the gain on the rental property becomes taxable, just as if you had sold it at the current fair market value. (There is also a deemed disposition if you change your principal residence into a rental property, but you can use this one to your advantage, by raising the ACB to current FMV.)
Don't you love acronyms?
Here's another disposition caution. Let's say you want to gift capital property to a family member. When dealing with a "non-arm's-length" person, you are deemed to dispose of the capital property at today's fair market value, even if you receive nothing for the gift.
If you make such a gift, be very careful how you document it. Changing title is usually done with a lawyer's help, and lawyers are trained to include "consideration" for any contract or transaction. Typically, this means selling for one dollar.
Do not do this! Selling for one dollar means the seller still has the capital gain to fair market value, but the cost base of the "buyer" is one dollar. This means that immediately there is a future gain liability of half the difference between one dollar and the FMV, growing as the property increases in value.
If, instead, this transaction is documented as a gift for zero consideration, then the receiver's cost base for a future sale is today's fair market value, a much higher figure, and therefore less capital gain on a disposition in the future.
David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).