If you are considering selling income or investment property, here is what you should know about capital gains.
Whether you are contemplating turning a principal residence into in income property or considering real estate investing, knowing how to navigate capital gains tax law can save you money come tax time.
If you own property that is not a principal residence, the revenue generated from selling that property can be taxed under Revenue Canada’s Taxation Laws as capital gains.
By educating yourself on how capital gains is applied to the sale of property and knowing what the CRA considers to be a “sale” of property, you will be able to minimize the amount of capital gains tax you have to pay at the end of the year and, perhaps, even avoid it altogether.
What is capital gains?
According to Revenue Canada (CRA):
- Capital gain occurs when you sell, or are considered to have sold, a capital property for more than the total of its adjusted cost base and the outlays and expenses incurred to sell the property.
- Capital loss occurs when you sell, or are considered to have sold, a capital property for less than the total of its adjusted cost base and the outlays and expenses incurred to sell the property.
- Capital property includes:
- Cottages
- Securities – stocks, bonds, units of a mutual fund
- Land, buildings, equipment, used for business or for rental income
You will have a capital gain or loss when you have or are considered to have sold capital property.
Here are some examples that are considered a sale:
- Exchanging one property for another
- Giving property (other than cash) as a gift
- Transfer of property to a trust
- Property is expropriated
- Property is stolen or destroyed
- Change in all or part of a property’s usage
- Emigration from Canada
- The owner dies
In terms of real estate, the above conditions are considered a sale that may lead to a capital gain or a loss that must be claimed the year it occurred.
How is a loss or gain determined?
If you sell a property for more than you paid for it (less any legitimate cost incurred from its sale), you have a capital gain.
Alternatively, if you experienced a loss from the sale of the property, you have incurred a capital loss.
If you owned the property personally, the capital gain is added to your annual income and the loss is deducted from your income. If your business owned the real estate, the capital gain or loss is applied to your business income for that year’s tax filing.
How is a capital gain calculated?
According to Revenue Canada, ½ of the income received from the sale of
the property (less any acceptable costs incurred from the sale) is taxable. If
you owned the property personally, that ½ is added to your personal income and
taxed based upon whatever tax bracket you fall under. Because Canada employs a
progressive taxation system from personal income, that percentage of tax
varies.
To see that federal tax rate for your personal income,
click here. To find out what tax rate you fall into provincially or territorially,
click here.
.
For example,
If you sell an investment property and profit $50 000, after any legitimate costs of the sale are deducted, $25 000, or ½, of that profit is added to your taxable income for that year. If you fall into the $47 to 93 000 income range, you would pay approximately 35.5% tax on that $25 000 capital gain, which amounts to $8 875.
Similarly, if you incurred a $50 000 loss from the sale of property, your
allowable capital loss would be ½ or $25 000 and could be applied against your
taxable capital gains for that year.
The same applies if the real estate is owned by your business and will be
applied to your business tax filings.
Learn how to calculate capital gains and losses using this quick guide from the CRA.
Can paying capital gains tax be minimized or avoided?
The simplest way to avoid or offset any capital gains tax is to counter
them with any capital losses incurred.
If you do not have any capital losses to offset or zero out any gains, there are other ways to minimize the amount of tax you will have to pay.
If the property is a residential rental property, you may be able to avoid paying capital gains tax by:
- If you do not already own a principal residence, you may be exempt from paying capital gains by claiming that property as your principal residence.
- If you won the home in a lottery and already own a principal residence, you may be exempt if you sell the winnings quickly because the home has not appreciated.
- Rent out less than 50% of your residence in order to keep the principal residence exemption
If you own a multiplex and reside in one unit, you can offset the gains if you keep meticulous records and only claim the costs incurred in maintaining the rented units. When you sell, you can deduct the portion of the gain that was your principal residence.
Let’s break this down.
Let's say you buy a duplex for $400,000 and rent out one unit for $1,500 per month and live in the other.
Each year you report your annual rental income and offset these earnings
with expenses associated with maintaining the rented unit. Keep in mind, you
cannot deduct expenses for the personal portion (principal residence) of the
duplex.
Four years later, you sell the duplex for $500,000.
cause 50% of the property is used for personal use, you can shelter 50% of the $100,000 capital gain.
The CRA is cracking down on real estate that generates income for the owner. In order to qualify for the principal ownership exemptions, you CANNOT rent out more than 50% of the property.
Furthermore, in order to be sure that you will qualify for the principal ownership exemption when purchasing real estate investments, it would be wise to consult a professional accountant.
What is considered a principal residence and how do I designate a property as such?
For taxation purposes, a property qualifies as your principal residence for any year it meets
all of the following
four conditions
- It is a housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation.
- You own the property alone or jointly with another person.
- You, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year.
- You designate the property as your principal residence.
Keep in mind that . . .
For any years the property was not your principal residence, capital gains will have to be claimed. For this reason, meticulous record keeping is paramount. Otherwise, the income received from the sale of that property could all be subject to capital gains taxation by the CRA.
The property being claimed as a principal residence must be inhabited by
the taxpayer or by his or her spouse or common-law partner, former
spouse or common-law partner, or child, during that tax year.
According to Revenue Canada, family members include:
- the taxpayer’s children, except those who were married, in a common-law partnership or 18 years of age or older during the year
- where the taxpayer was not married, in a common-law partnership or 18 years of age or older during the year:
- the taxpayer’s mother and father; and
- the taxpayer’s brothers and sisters who were not married, in a common-law partnership or 18 years of age or older during the year.
If you are thinking that you could have a child or sibling reside in one
property and you live in another before the sale so any revenue generated is
tax exempt, think again. In order to close that loophole, the CRA amended the
tax laws around capital gains with Bill C-63. Therefore, as of 2017, only one
property can be designated as a principal residence for a particular tax
year per family.
As of 2017, in order to qualify for exemption from capital gains for the sale of a property you claim to be your principal residence, you MUST complete a T2091INDform,
Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust)
What about Gifting Real Estate?
While giving real estate prior to death may help the giver avoid probate and estate taxes upon death, it is considered a sale in the eyes of the CRA. Although Canada does not have gift taxes per se, this type of transfer of property can result in capital gains taxes for the giver and the recipient.
The CRA will consider the value of the property at time of transfer and measure it against the purchase price and the difference will fall under capital gains and ½ of that will face taxation for the giver. If the recipient sells the property (and it the principal residence exemption does not apply) the CRA will measure the value of the property at time of transfer against the selling price and the difference will be considered capital gains.
What if the property was my primary residence before I rented it out?
Let’s say you bought real estate and lived in it as your primary residence. After a few years, you buy another property, move into it, and rent out the first property before selling it. Technically, the moment you changed the property’s usage is when capital gains would be applied.
In order to minimize how much is taxed as capital gains, a formal appraisal of the property at the time you changed its use from a principal residence to a rental property must be done. In this way, the CRA will consider any appreciation from the time the property became an income property to the time of sale as capital gains, NOT the entire time you owned it.
As a result, any costs incurred while it was an income property can also be deducted from the capital gains much easier as you will have a formal date of use change along with all records showing the costs of maintaining the income property.
What happens if I inherit international property?
Canada does not allow exemptions for international property. It would fall under the same capital gains as property owned in Canada. However, by putting the property into a trust versus putting it in yours or your company’s name, can shelter the property from taxation.
The laws addressing international property are always changing and can be quite complex so consult a professional.
What if I marry and I sell my principal residence in order to move into my partner’s principal residence?
If both of you own and live in a principal residence, in order to receive the principal residence exemption when selling one of the properties, you must sell it before marrying and cohabiting.
If you move into one of the principal residences before selling the other, the property you do not live in no longer qualifies for the exemption and capital gains will have to be claimed.
If I bought vacant land and then built my principal residence on it, will I have to pay capital gains on the entire sale profits?
No. If you bought vacant land and built a principal residence on it a few years later, you only have to pay capital gains for the years you lived in the home less the cost of building it.
For example:
In 2002, Mr. Smith acquired vacant land for $50,000. In 2005, he constructed a housing unit on the land, costing $200,000, and started to live in the home. In 2011, he sold the property for $300,000. Mr. Smith’s gain from the sale of the property is equal to his $300,000 proceeds minus his $250,000 adjusted cost base = $50,000 (assume there were no costs of disposition). Mr. Smith can designate the property as his principal residence for the years 2005 to 2011 inclusive, but not for the years 2002 to 2004.
The principal residence exemption formula will not eliminate his entire $50,000 gain but can eliminate $40,000 of that gain, as shown in the following:
Applying the formula,
A × (B ÷ C):
A is $50,000
B is 1 + 7 (being tax years 2005 to 2011)
C is 10 (being tax years 2002 to 2011)
= $50,000 x (8 ÷ 10)
= $40,000
Instead of being taxed for ½ of his total $50 000 gain, Mr. Smith would only be taxed on ½ of $10 000 of the total gain from the sale of this property.
With the CRA cracking down on using real estate as a tax shelter, paying tax on capital gains is virtually unavoidable.
However, with careful record keeping and professional consultations every step of the way, the amount of tax owed can be minimized and sometimes zeroed out completely.
No one likes to pay more taxes but at least the capital gains tax is a lot less than what would be owed if all the revenue generated from the sale of property was considered income. At least half, in fact!
Source of information: Revenue Canada Taxation at www.canada.ca
