Taxation of Investment Capital Gains and Losses

A capital gain or loss is, at its most basic, simply the difference between the amount received on the sale of an asset and the amount paid for that asset when it was originally acquired. Under Canadian tax law, only one-half of that amount (referred to as a “taxable capital gain”) is required to be included in income.

For example, Shareholder A, who purchased shares for $1,000 and sold them one year later for $1,500, has generated a capital gain of $500. Since only one-half of the capital gain is required to be included in income, the taxable capital gain (and therefore the amount to be included in income) is actually $250.

The taxable capital gain, once included in income, is treated as “regular” income and taxed at the taxpayer’s usual tax rate. However, because only one-half of the gain has been included in income,
capital gains are effectively taxed at 50% of the rate that would have applied, for instance, to salary or interest income.

Where a loss is sustained on the sale of an asset, the resulting capital loss is similarly reduced by one-half, as follows:

If the shareholder in the above example sold his or her shares for $800, then a capital loss of $200 ($1,000 – $800) would result. One-half of that amount, or $100, represents the “allowable capital loss” arising from the transaction.

Where a taxpayer has incurred a capital loss, that loss can be deducted in the computation of income for the year, but only against taxable capital gains earned during the year, and not against any either kind of income (i.e., salary or interest income).

Let’s say Shareholder A undertook two share-sale transactions during 2010. The first sale generated a capital gain of $1,000 and a taxable capital gain of $500. The second sale, however, resulted in a loss of $200 and, therefore, an allowable capital loss of $100. In calculating income for the year, the taxpayer can deduct the $100 allowable capital loss from the $500 in taxable capital gains, giving him or her $400 in net capital gains for the year. That amount is then reported on the tax return for 2010 at line 127.

While allowable capital losses incurred in a particular tax year may only be deducted against taxable capital gains earned in that year, taxpayers who incur “excess” losses may carry over those losses and claim them in the same way in any of the three previous taxation years or in any subsequent taxation year.

Capital gains exemption/special treatment

From 1985 to 1994, all individual Canadian residents were eligible for a lifetime capital gains exemption of up to $100,000. That exemption was eliminated in 1994, but a similar exemption for capital gains earned in relation to the disposition of shares of small business corporations and qualifying farm property was retained.

As is the case in other areas of the Canadian tax system, investments in such entities remain eligible for more favourable tax treatment in a number of ways.

Every Canadian taxpayer is allowed to claim a tax exemption on up to $800,000 for 2014 (the former limit was $750,000) in capital gains earned on qualifying small business corporation shares. A
similar exemption is available with respect to capital gains earned on the sale of qualifying farming and fishing property. However, it should be noted that the lifetime limit of $800,000 applies to total gains earned on all such qualifying property, both small business and farming and fishing. The rules governing the types of property that qualify for the exemption and the mechanics of claiming the exemption are exceptionally complex, and professional tax advice should be sought by anyone seeking to take advantage of these rules.

Taxpayers who incur losses on dispositions of shares of a small business corporation may also benefit from beneficial tax treatment. Such losses are characterized as “business investment losses”,
and one-half of such losses, known as “allowable business investment losses”, can, unlike regular capital losses, be deducted from ordinary income, such as income from employment or investment income. The definition of what constitutes a small business corporation for this purpose is complex, as such corporations must satisfy tests involving corporate residence, corporate control, and, most important, the nature of the corporation’s business. Once again, taxpayers who believe that they have incurred capital losses which might qualify as business investment losses should seek professional tax advice.

Capital gains tax rates

As is the case with dividends, there is a good deal of variation in the tax rates applied to capital gains, owing to differences in provincial tax rates. However, in the case of capital gains, the top marginal rate can be easily calculated as one-half of the rate that would apply to salary or interest income received by the same taxpayer, as a result of the one-half inclusion rate. Consequently, for 2008, the top marginal rate applied to capital gains income would range from about 19% to 25%, depending on the taxpayer’s province or territory of residence.

The articles posted here provide information of a general nature. These articles should not be considered specific advice; as each vistor’s personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in these articles.

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