How To Avoid Canada’s Capital Gains Tax

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How to avoid Canada's capital gains tax
Article Overview

No one likes to pay taxes, and when you invest in Real Estate or Stocks, you may need to pay capital gains tax when you sell them. Are there ways to avoid paying capital gains tax? Though many require some setup, there are a few ways where you can minimize your capital gains tax when you sell your investments.

To help all your tax needs, here are a few of our top articles for you.

How To Avoid Canada’s Capital Gains Tax

1. Invest money in a tax shelter

You might think of tax shelters as a canopy for your assets. A tax haven is a place where your investments may grow without incurring any taxes. You are free to acquire and sell stocks at will without incurring any tax penalties. (That said, you can’t deduct any capital losses from your overall income either.)

In Canada, RRSPs are among the most used forms of tax deferral. Unlike non-registered accounts, any earnings from an RRSP are not subject to taxation in the year they are made. Since you did not pay tax on your income when you made the contribution, the money you remove will be subject to tax at your full marginal rate.

When it comes to hedging against capital gains, a TFSA performs the same role as an RRSP. You get to retain all of the money you earn from trading inside your TFSA. Since you had paid tax on your donations, the CRA will not tax you again when you withdraw any amount. In other words, if you put away $6,000 a year after taxes, invest it for 30 to 50 years, and it grows to $1 million (which is doable, particularly when you don’t pay capital gains tax), you can take out the whole amount without having to worry about paying any taxes on the growth.

A registered education savings plan (RESP) is another vehicle that allows your money to grow and avoids the capital gains tax.. You should probably invest in low- to medium-risk assets since you will need the money for your child’s schooling in the near to medium future. Your kid will have to pay some tax on the withdrawals, but the rate won’t be too high, given that their income is likely to be rather modest while they’re in school. Please be aware that the account must be closed 35 years after it was started.

2. Balance out your capital losses

If you sell $1,000 worth of ABC stock and $2,000 worth of XYZ stock in the same calendar year, your net gain is $0 since the gains from the former are offset by the losses from the latter. There will be no capital gains tax to pay in such a case. Or, say you make a thousand dollars in profit but lose 500. Because of the loss, you were able to deduct, your after-tax gain is $500 instead of $1000. Only $250 of that gain is subject to taxation at your marginal rate.

Or, suppose you’ve had nothing but losses this year. If that’s the case, your losses may be applied to future or previous years. They may be carried back for up to three years to reduce taxable profits or carried forward forever to build up. Capital losses may be offset by other forms of income in certain circumstances; nevertheless, you should consider this possibility with an accountant.

It’s important to remember that you can’t merely sell some stock and buy it back right away in order to avoid paying taxes on the profit you made on the sale in order to balance your capital losses. The same goes for trying to sell your spouse on a stock. The Canada Revenue Agency does not permit “superficial losses” like that.

However, there is a really ingenious technique to avoid this. Selling a losing investment and reinvesting the proceeds into a comparable but not identical venture is known as “tax-loss harvesting.” To illustrate, suppose you have complete faith in the cannabis market. You invested $1000 in a cannabis startup, only to see your investment shrink to $500. You cash out $500 in losses by selling the stock and promptly reinvesting in another cannabis security or exchange-traded fund. Because of this, you may reduce your taxable income while still having the chance to profit from an industry you believe will rise.

3. Defer capital gains

Only if you received shares from a spouse or parent upon their death or divorce would you be able to avoid paying capital gains tax on those shares. As such, if your husband purchased 100 shares of ABC stock and then gave them to you when you got divorced, neither of you would have to pay capital gains tax. You have to pay the capital gains tax when you sell the stock. Instead of using the value when your spouse or parent gave them to you, you should use the value when they were bought.

4. Enjoy the benefits of the lifetime capital gain exemption

When selling private qualifying shares or farm or fishery property, certain small company owners are eligible for a lifetime capital gains exemption. Eligible stocks are those of a corporation with both Canadian ownership and significant operations in the country. Also, the taxpayer or a close family must have held the shares for at least 24 months before the sale. There will be a $913,630 lifetime cap in 2022. A tax expert should be consulted since the laws are intricate. Stocks do not qualify for a lifetime capital gains exemption.

5. Donate a percentage of your shares to charity

If you want to help out a good cause, why not give shares instead of cash? One of the benefits is that it minimizes the donor’s taxable income. In addition to receiving a tax deduction equal to the shares’ fair market value at the time of the gift, the “profit” from the shares is written off entirely.

6. Use capital gain reserve

If you sell an expensive piece of property, you may be able to pay for it with the money over a period of five years. It’s true that we pay more in taxes as our income rises, but it’s because of Canada’s progressive tax system. Let’s pretend you just made $250,000 via the sale of an investment unit to your kids. You would be subject to a marginal tax rate of 43.41 percent in Ontario. Alternatively, if you can stretch the gain out over five years at an annual rate of $50,000, your marginal tax rate would peak at only 20.05%, and you’ll retain more of your hard-earned cash. There is an increased risk of nonpayment on the part of the buyer if you need them to make installment payments to you over a longer period of time. If you plan on leaving a farm to your kids or grandkids, for example, you may be able to defer the gain on that sale for up to ten years.

The Future of Capital Gains Tax

There has been a significant increase in Canada’s deficit as a result of the Covid-19 outbreak, with the government borrowing nearly $225 billion to provide emergency payouts. So that it can repay this vast money, many analysts believe that the government will start to hike taxes. A number of experts have expressed the view that the capital gains tax is an area where reform is most needed. There has never been a set rate for capital gains taxation. Ahead of 1972, it was nonexistent. The figure climbed to 50% by 1980, and then 75% by 1990. Since the year 2000 alone, the inclusion rate slipped back down to 50%. If the government needs more money to pay its debts, it would likely raise the capital gains tax again.

Tips for Paying Less in Capital Gains Tax

While it may be difficult to completely sidestep capital gains tax in Canada, there are a few strategies that may help you pay less of it. As long as the funds remain in a tax-deferred account, the investor is exempt from paying capital gains tax on the profits. You may reduce your capital gains tax by offsetting them with capital losses; however, doing so precisely might be challenging. Giving shares to a good cause might also help you avoid paying CGT. If you want to sell a house that has appreciated in value, claiming it as your main residence for as long as feasible will help you pay less in capital gains tax when the time comes to sell.

The Best Way to Avoid Paying Canadian Capital Gains Tax

There are a number of legitimate loopholes one might use to avoid paying capital gains tax in Canada. Putting money away in a tax haven, offsetting gains with losses, postponing the realization of gains, making use of the lifetime capital gain exemption, donating shares to charity, and using the capital gain reserve are only six of the strategies discussed in this article.

FAQ

Gains in the value of a person’s capital, such as stocks and real estate, are known as capital gains. As such, the government prefers to treat some of this profit as taxable income. Half of a Canadian resident’s capital gains for the year are subject to income tax. That implies you have to add half of your capital gains to your income before taxing it. Based on your income and tax circumstances, a different percentage of your capital gains will be taxed as taxable income.

More than half of the company’s assets must have been actively employed in a Canadian business for at least 24 months before the sale may take place. In the preceding 24 months prior to the sale, neither you nor anyone linked to you may have possessed the shares.

Income from dividends, the sale of stocks or property (other than your primary home), and gifts of capital that generate income are all subject to capital gains tax in Canada. All of these forms of income are seen as taxable in some capacity, depending on the individual taxpayer’s marginal tax rate for the year in issue.

For as long as the house is used as the main residence, the owner is free from paying capital gains tax on any profit made from the sale of the property. The Internal Revenue Service (IRS) does not specify a minimum period of ownership necessary to qualify for this exemption. The guidelines from the CRA only state that you need to “ordinarily occupy” the space for a “short amount of time,” which might be interpreted in a number of ways.

In Canada, converting an inherited property into a principal home is the major method for avoiding capital gains tax. You or the estate wouldn’t have to pay capital gains tax if the house was the decedent’s principal residence when they transferred it on to you. The principal dwelling exemption is to blame for this. If you turn around and sell the property, though, you’ll owe tax on half of the profit.

One restriction that affects certain small company owners is the lifetime capital gains exemption. If a person sells qualifying shares in a privately held company or agricultural or fishing property, they may defer capital gains tax on the sale up to a lifetime maximum. Shares in a privately held firm that is both operational and majority owned by Canadians are considered eligible. The taxpayer or a close relative of the taxpayer must have held the shares for at least 24 months before the transaction to be eligible for the exemption. There will be a $971,190 lifetime cap in 2023. A tax expert should be consulted since the laws are intricate. Stocks are excluded from the lifetime capital gains exemption.

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Written by:

Jim Pan, CFP, MFA-P

Jim is a dedicated, fee and advice only independent Certified Financial Planner with a focus on supporting healthcare business owners during their crucial growth phase. His expertise lies in offering comprehensive solutions to minimize taxes while embracing a holistic approach. With a career spanning back to 2010, Jim has established a strong presence in the financial industry. He proudly holds a range of designations, including Certified Financial Planner (CFP), and Master Financial Advisor - Philanthropy (MFA-P). He is currently pursuing additional designations and qualifications to better serve his clients and community. Beyond his qualifications, Jim is a member and an esteemed participant in the Million Dollar Round Table (MDRT), an exclusive global association comprising the top 1% of financial advisors. Jim's commitment extends to the community, where he spearheads numerous charitable fundraising events and plays an active role in enhancing the well-being of others. Additionally, he has contributed significantly by serving on the board of the Canadian Mental Health Association in Vancouver. Currently, he volunteers with Junior Achievement of British Columbia (JABC) to present personal finance topics to youths.

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