If you’ve been wondering how to avoid the capital gains tax on rental property in Canada, look no further. We’ve prepared an extensive guide with a few useful tactics you can employ.
Read on to get a better idea of what are capital gains taxes and ways you can reduce them.
How to Avoid the Capital Gains Tax on Rental Property in Canada?
One way to reduce the capital gain tax in Canada is using capital losses. If you lose money on one investment, you can use it to reduce the amount of money you can pay in taxes on other investments.
Assume you hold two stocks, one of which is worth 10% more than the price you bought it for, while the other is worth 5% less. If you sold both stocks, the loss on one would offset the capital gains you’d have to pay on the other.
You could sell your property when your income is the lowest. Your tax bracket, which is established based on your income, determines your capital gains tax rate in Canada. Being clever about the time of sale could help you save money on taxes.
If you or your spouse loses or quits a job, or if you’re going to retire, sell your home during a low-income year to lower your CGT rate.
Moreover, you could also hold your future investments in tax-advantaged accounts to avoid unnecessary capital gains. Tax rates for gains on stocks held for less than a year are 15% for most investors and 20% for high-income taxpayers.
Consequently, delaying the sale of valued equities until they qualify for long-term capital gains treatment may be a good idea.
Next, you can consider donating your property to causes you care about. Donating long-term appreciated assets to charity in Canada can decrease your capital gains tax liability.
You can not only deduct the market value of what you contribute from your income taxes, but you can also avoid paying up to 20% in capital gains tax.
Another thing you can do to reduce capital gains taxes is to carry your losses to the following year. A tax loss carryover (or carryforward) allows taxpayers to extend a current-year taxable loss to a future-year tax period.
Taxpayers can use capital losses that exceed capital gains in a given year to offset ordinary taxable income up to $3,000 in each subsequent tax year until depleted.
Harvesting your tax losses is yet another option for avoiding the capital gain tax in Canada. Tax-loss harvesting is when you sell some equities at a loss to offset profits made by selling other stocks at a profit.
As a result, you will only pay taxes on your net profit, or the difference between what you earned and what you lost, lowering your tax burden.
Finally, you can use a TFSA or an RRSP account. Consider putting your money into a TFSA to assist build up your capital if you’re in a low tax bracket. As your income increases, you can withdraw funds from your TFSA and contribute to your RRSP to reduce your taxes.
What Is the Capital Gain Tax in Canada?
The profit you make when you sell or give away an asset that has gained value is subject to capital gains tax. Some assets, such as your primary residence, are tax-free. However, if the value of your rental property has increased since you purchased it, you may be required to pay CGT on a portion or all of the profit when you sell it.
Moreover, the capital gains tax in Canada doesn’t only apply to real estate but also to shares, bonds, coin collections, and jewellery.
The term “capital gains” refers to the increase in value of a capital asset when someone sells it. Simply defined, you have a capital gain when you sell an asset for more than you paid for it.
Opposite to a capital gain, a capital loss occurs when the value of a capital asset, such as an investment or real estate, decreases. This loss realizes after you sell a capital asset for less than its purchase price.
When Canadian investors sell a capital property for more than they bought it, the Canada Revenue Agency (CRA) deducts half of the gain. Thus, the capital gains tax rate in Canada is 50%.
Gains on the sale of certain property types are not subject to CGT if they are a principal residence. The sale of your principal residence is the most popular capital gain exemption. A principal residence is a home where you or your spouse, previous spouse, or child live.
Since October 2016, the seller must disclose the sale to the Canada Revenue Agency to claim the exemption, even though capital gains on the sale of a principal residence are not taxable. The seller has to report information like the purchase date, the selling price, the sale date, and a description of the property.
Other types of property also are not subject to CGT. Here are some examples: capital gains from the sale of business inventory, land purchased to resell, and profit from the sale of personal-use property with a cost and selling price of less than $1,000.
The lifetime capital gains exemption in Canada (LCGE) permits people to defer capital gains for the rest of their lives.
How to Calculate the Capital Gain Tax in Canada?
You can calculate the capital gains tax using the following formula:
- Capital gain = proceeds of disposition – (adjusted cost base + disposition expenses)
Because capital gains are taxable to 50% of their value, you must multiply the capital gains by 50% to calculate the amount to include on your income tax and benefit return. Below are some examples for calculating the capital gains tax rate in Canada.
Adjusted Cost Base
The adjusted cost base for simple buys and sells is the book value plus any commission paid to acquire the stock. For example, if you paid $300 for 100 shares of Claybar Contracting Company and received a $30 commission, your ACB would be $330, which includes the price of the shares plus the fee ($300+$30).
Let’s imagine you want to acquire more shares of Claybar Contracting Company, but the price has gone up. This time, for a total of $1,000, you purchase 200 shares. The commission is the same, $30. For this transaction, your ACB is $1,030 ($1,000 + $30).
When you sell those investments, they use your ACB to determine whether you profited or lost money. However, because you have no means of knowing which shares in your pot had which ACB, you must calculate the average ACB of each share.
You get that by adding the ACBs together and dividing them by the total number of shares you hold.
When you add up the ACB for the two transactions, you’ll see that they cost $330 + $1,030 = $1,330. As a result, your ACB for Claybar Contracting Company is $1,330.
Divide your total ACB by the number of shares you hold to get your total ACB. $1,330 / 300 shares = $4.43. The last part is required to determine whether or not you made a profit.
Capital Gain Example
You’ve decided to sell some Claybar Contracting Company stocks. Let’s go over it again: A capital gain occurs when you sell an investment or real estate for more than its purchase price. A capital loss occurs when you sell an asset for less than its purchase price.
When the stock of Claybar Contracting Company reaches $30 per share, you decide to sell 100 shares. The brokerage fee is $40. 100 shares x $30 = $3,000 – $40 fee = $2,960. This is the selling price.
Start by calculating your ACB per share on your Claybar Contracting Company shares to determine whether you made a profit or not. We came up with a figure of $6.65.
To calculate your ACB on the transaction, multiply your ACB per share by the number of shares sold. $6.65 x 100 = $665.
Subtract the ACB from the sale price of those shares. Your selling price is $2,960 – your ACB $1,030 = $1,930. You have a capital gain because it exceeds your ACB.
Capital gains are taxable in Canada at 50% of their value. In this case, you’d need to add $1,930 to your income. Other sources of income determine the amount of tax you pay.
The capital gain tax in Canada can soon build up if you sell a rental property for a high profit. Keeping an eye on home market trends and analyzing your total financial status will help you decide if now is the best time to sell to save money on taxes.
If your average income is down for the year, selling a rental property for a capital gain may not be as painful if you’re in a lower tax bracket. However, speaking with a financial expert can assist you in determining the best strategies for minimizing capital gains tax.
There are two methods for calculating rental income for taxes. In most circumstances, you’ll use the accrual method. For this method, you’ll need to: report rental income in the fiscal period in which you have earned it, regardless of when you have received it. And deduct expenses in the fiscal period in which you have incurred them.
Another option is the cash method. You’ll use the cash method if you have nearly no receivables and no expenses outstanding at the end of the year. For this method, you’ll need to: report rental income in the fiscal year you have received it. And deduct expenses in the fiscal period in which you have incurred them.
Canadian capital gains are taxed at 50% of their value.
To avoid capital gains in Canada, taxpayers need to live in a house or an apartment for at least two years.
To avoid capital gains tax on rental property in Canada, you can use capital losses, sell your property when your income is the lowest, hold your future investments in tax-advantaged accounts, donate your property, carry your losses to the following year, harvest your tax losses, or use a TFSA or an RRSP account.