Capital Gains Tax on the Sale of Real Estate Properties
One of the most burning concerns for Canadians today is tax. The Government is able to tax income, consumption and capital. With income taxes at onerous levels and consumption taxes like GST and PST/HST extremely unpopular, taxes on capital are likely to be examined more closely. It is unlikely that the government has failed to notice that during the next two decades or so $1 trillion in assets will pass from the over 55 generation to their children. Given the record of past governments in these matters, there is little doubt that this intergenerational asset transfer will be subject to increased taxation in the future.
A capital gains tax (CGT) is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.
For equities, an example of a popular and liquid asset, national and state legislation often has a large array of fiscal obligations that must be respected regarding capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on the stock market. However, these fiscal obligations may vary from jurisdiction to jurisdiction because, among other reasons, it could be assumed that taxation is already incorporated into the stock price through the different taxes companies pay to the state, or that tax-free stock market operations are useful to boost economic growth.
Capital gains taxes were introduced in 1972. The inclusion rate (the amount of the gain that is subject to income tax) was initially 50% then 66% in 1988, 75% in 1990 and back to 50% since 2000). It is reasonable to assume the rate might increase. During the same time period, the applicable exemptions on capital gains have also been changing. The $500,000 exemption introduced in 1985 was capped at $100,000 for individuals in 1988 restricted with regard to real estate investments in 1992 and then removed completely as far as individuals are concerned. It’s likely the government will consider further tinkering with the exemptions as well.
In Canada :
Currently 50.00% of realized capital gains are taxed in Canada at an individual’s tax rate. Some exceptions apply, such as selling one’s primary residence which may be exempt from taxation. Capital gains made by investments in a Tax-Free Savings Account (TFSA) are not taxed.
For example, if your capital gains (profit) is $100, you are only taxed on $50 at your marginal tax rate. That is, if you were in the top tax bracket, you would be taxed at approximately 43%. A formula for this example using the top tax bracket would be as follows:
Capital gain x 50.00% x marginal tax rate = capital gain tax
= $100 x 50.00% x 43%
= $50 x 43%
In this example your capital gains tax on $100 is $21.50, leaving you with $78.50.
The formula is the same for capital losses and these can be carried forward indefinitely to offset future years’ capital gains; capital losses not used in the current year can also be carried back to the previous three tax years to offset capital gains tax paid in those years.
For corporations as for individuals, only 50% of realized capital gains are taxable. The net taxable capital gains (which can be calculated as 50% of total capital gains minus 50% of total capital losses) are subject to income tax at normal corporate tax rates. If more than 50% of a small business’s income is derived from specified investment business activities (which include income from capital gains) they are not even allowed to claim the small business deduction.
Capital gains earned on income in an RRSP are not taxed at the time the gain is realized (i.e. when the holder sells a stock that has appreciated inside of their RRSP) but they are taxed when the funds are withdrawn from the registered plan (usually after converting to a registered income fund.) These gains are then taxed at the individual’s full marginal rate.
Capital gains earned on income in a TFSA are not taxed at the time the gain is realized. Any money withdrawn from a TFSA, including capital gains, are also NOT taxed.
Unrealized capital gains are not taxed.
There is NO CAPITAL GAIN tax on disposition of a principal residence in Canada.
1. What is Principal Residence
2. What type of properties may be called Residence
3. Factors based to determine the Capital Gain Tax
4. Some possible exemption
5. Who should report to Canada Revenue Agency
6. Relationship to the Taxpayer’s Business
7. Frequency of Transactions
8. Nature of Transaction and Assets
1. What is Principal Residence:
You or a personal trust (but not a corporation) owned the property solely or jointly.
You were a resident of Canada throughout your ownership of the housing unit.
The Principal Residence was ordinarily inhabited by you, your spouse, common law partner, (current or former) or your child. (adult or underage).
You, your spouse or your children under the age of eighteen DO NOT own another property, which they designated as their principal residence.
The primary purpose for acquiring and selling your principal residence was NOT to make a profit.
The property’s use was NOT totally or partially changed throughout your ownership. (Post 1971) Partial conversion gives partial exemption see below.
The land on which the principal residence was built does NOT exceed half a hectare (5,000 square meters or 1.23 acres). This limitation could be increased depending on zoning by-laws and proof that a larger acreage was necessary for the full enjoyment of the property.
You did not own the land on which you built your principal residence for more than two years before putting a building on it and ordinarily inhabiting it.
2. Factors based to determine the Capital Gain Tax
Apartment or unit in a duplex, apartment building or condominium.
Houseboat.Leasehold interest in any of the above.
Share of the capital stock of a co-operative housing corporation, if such share is acquired for the purpose of obtaining the right to inhabit a housing unit owned by that corporation.
3. Factors based to determine the Capital Gain Tax:- Over the years, Capital Gain Tax has been determined based on a number of factors such as the intention of the taxpayer, relationship to the taxpayer’s business, frequency of transactions, length of time held, nature of the transaction and objects of the corporation. Should a debate proceed to the Tax Court of Canada, the Court will consider relevant factors concerning taxpayer conduct before, during, and after the period under appeal. Certain factors carry more weight in the process.
4. Some possible exemption:- Profits would likely be taxed as regular business income if a taxpayer buys and sells real estate on a regular basis. However, if the taxpayer can prove that these dispositions were a planned and necessary part of a total investment program, then there may be a case for capital gains treatment of the profit. In the case of farmlands, if the taxpayer purchased or inherited the land and lived on it for a period of time, a disposition of the property will most likely be regarded as a capital gain. Up until 1982, a couple could own two properties, e.g. the home primarily lived in, and a recreational property for example, and each designate one of the properties as his or her principal residence, and therefore sell or transfer both properties tax-free. The federal government changed the tax laws as of 1982, so there can only be one principal residence for tax purposes.
However, let’s say that you do not have any children, or your children do not want to use your vacation property as they own their own second properties, or live too far away geographically. In this situation, passing the vacation property down through the generations is not an option. You wish to sell it for your retirement, lifestyle, or financial needs. Maybe due to health reasons, you do not use the property much anymore, or it is becoming too costly to maintain.
You could still have some tax saving options available. Depending on your circumstances you might be able to designate one of your two properties as your principal residence for tax purposes. In fact you may have several residences that you ordinarily inhabit and can designate any one as your principal residence for each of the years you own them, but just one principal residence per year.
For example, if you owned a Whistler, B.C., chalet that had appreciated $2 million over 15 years, that originally cost you $500,000, that would be a $1.5 million capital gain. If the residence you lived in primarily was located in Chilliwack, B.C., that cost you $100,000 five years ago, and is now worth $300,000, that would be a $200,000 capital gain. If you deemed or designated your Whistler property as your principal residence for tax purposes when it was sold in 2006, you would not have to pay capital gains tax.
What about your Chilliwack property in this scenario? When it was sold, you would calculate the portion of the time you held the property prior to the sale of the Whistler property, e.g. five years, and add one year. Then calculate the total number of years before you sold the Chilliwack property. For example, if you sold the Chilliwack property in 2016 and therefore had held it for 15 years in total, the portion of capital gains that you would need to declare would be 5 years + 1 = 6 over 15 years, or 6/15th of the capital gains on sale. If it sold for a $500,000 gain, you would need to declare a gain of approximately $200,000, and pay tax on 50% of that gain, e.g. $100,000. Depending on your personal taxable income and marginal tax rates in that taxation year, and based on tax advice, you might have to pay up to $50,000 for the property sale.
5. Who should report to Canada Revenue Agency:- The Income Tax Act does not specifically set out whether or not a gain or loss is capital in nature. The taxpayer is responsible for reporting the gain as income or capital gain. This report may then be challenged by the Canada Customs and Revenue Agency with the onus of proof on the taxpayer.
6. Relationship to the Taxpayer’s Business:- The Tax Court will undoubtedly classify profits as taxable under ordinary business income when a taxpayer uses expertise acquired in regular business activity to generate a profit on the purchase/sale of similar or related commodities. The court also looks at the time and attention the taxpayer spent on the transaction. Real Estate transactions of contractors, renovators, brokers, (agents) salespeople, and appraisers have typically fallen under close scrutiny.
7. Frequency of Transactions:- Revenue Canada will assess how often the taxpayer engages in the sale of capital property. Usually, frequency of such occurrences suggests the carrying on of a business for profit. Assessment as ordinary business income will be the result. However, even an isolated transaction can be so judged, given the right set of circumstances.
8. Nature of Transaction and Assets:
Taxability as income may be indicated if the asset cannot normally be used either personally or for investments purposes. Mortgages are often judged under this test. If the mortgages are purchased at substantial discounts or have a short maturity date, the mortgagee may be viewed as being in a business that realizes profit from the transaction, thus invoking business income as opposed to capital gain.
Appropriate expert advice from a Chartered Accountant or Tax Consultant to be /should be sought in regard to capital Gains issues and exemptions.
Please contact me should you have a question in this regards for Buying or Selling Real Estate Related matters.
The information provided in this blog is for information purpose only, Author is not Liable for any Misuse or Other, Use on your risk.Please verify the codes from local and federal laws and use right professional advise in the matter.
Author is Licensed Real Estate Agent and Mortgage Agent, and provide service in the respective field only.