What is capital gain and how is it taxed in Canada?

Overview

Capital gain arises when you dispose of, or are deemed to have disposed of, a capital property. Capital properties include stocks, bonds, mutual funds, real estate, interest in partnership, or certain collections. Under the current rule, only one- half of a capital gain is taxable; taxable portion of gain is included in your income.

Generally, capital properties are acquired with the intention to holding them to earn income (for example purchasing shares or GICs to earn dividend or interest income). However, if your intention was to resell the properties rather than hold it to earn income, the CRA may consider that you are carrying on a business of buying and selling for profit and therefore treat the property as inventory rather than capital assets.

Gain or loss arising from the sale of inventory are treated as business income and fully taxable, whereas only one-half is taxable for capital gain. There have been many disputes about this classification because capital gains receive preferential tax treatment; the CRA sometimes challenges the characterization of a gain as a capital gain and argues it should be treated as business income based on various factors. The CRA usually considers following factors when determining whether a gain on sale of property is capital gain or business income.

1. The relationship of the transaction to your business- Was your transaction similar to your regular business income earned. For example, a real estate developer who purchases a building for rental purposes may be considered business rather than investment when they sell the property.
2. Nature of asset- Was it a one-time sale or did multiple transactions occur in the year? A higher volume of similar transactions suggests business activity due to increased involvement. Number and frequency of transactions – was it one time
3. Length of investment period – How long did you leave the investment before selling it? Assets typically held for long-term income are more likely to be considered capital assets.
4. Feasibility of your intention – If your primary intention of investment is frustrated (unreachable), secondary intention (such as resale for profit) may use to begin with.
5. Extent of to which intention was carried out – If little or no effort was made to use the asset as a capital property, this could suggest it was held as inventory, supporting a business classification.

Therefore, it is crucial that the way you categorize a property matches your intention at purchase and how you actually use the asset. Proper documentation and treatment help avoid future disputes and costs with the CRA.

For assistance with this categorization, please contact one of our tax specialists.

How Capital gains are taxed in Canada?

The simplest of capital gain calculations on the sale of capital properties is as follows:

Selling price – Adjusted Cost Based (ACB) – selling expenses = Capital gain.

Adjusted Cost Base is your original invested amount plus other adjustments made to it such as broker fees, legal fees, and improvement.

Selling expenses include commission paid, broker fees paid on sale of securities, realtor fees paid on sale of real estate, legal fees.

For example:

• Sold investment property for $100,000
• ACB = $50,000
• Selling costs = $5,000
• Capital gain = $100,000 – $50,000 – $5,000 = $45,000
• Taxable capital gain = $45,000 × 50% = $22,500
  This $22,500 is added to your other income for the year and taxed at your marginal tax rate.

What if you sell an investment at a loss?

Allowable capital losses (50% of full capital losses) are deductible to the extent of taxable capital gain included in your income. If your allowable capital losses are more than gain included in income, excess may be carried back three years and forward indefinitely.

You should note that capital losses on depreciable assets (for example, cars equipment, buildings) are not allowed therefore you cannot use this to offset your capital gain.

Investment business loss: if you suffer losses from investing in Small Business Corporation (SBC) shares or debt, the CRA provides relief for investments in shares or debt of a failed small Canadian business. An SBC is a Canadia- Controlled Private Corporation where all or substantially all of (90%) of its assets are used in an active business carried on primarily (50%) in Canada. A Business Investment Loss (BIL) is full amount of the loss, and an Allowable Business Investment Loss (ABIL) is one-half of the BIL.

When a BIL is realized, you can deduct the BIL from any source of income. If the ABIL is not fully used in current year, it may be carried back 3 years and carried forward 10 years and deduct against any source of in those years.

This is just an overview; the rules are complex and involve other interrelated provisions. Therefore, please contact us if you have an ABIL in any year or need assistance determining if your loss qualifies as an ABIL.

What happens if the principal residence is sold in Canada?

In Canada, a principal residence receives special treatment. Usually, when you sell principal residence in Canada, all or part of the gain is tax-exempt to the extent it was designated as your principal residence for one or more years.

Principle residence is a home where you, your spouse or common-law partner, or your children ordinary inhabitants. Ordinally inhabit means that, at some time during the year, you, your spouse, commo- law partner, former spouse, former commo- law partner, or lived in the property. Principle residence includes house or any house units (condo, cottage, mobile home etc.).

Note that only one principal residence can be designated by a family, and it is limited to the building and one- half hector of the land, unless you can prove that the excess land is necessary for your enjoyment of the property.

If the home is qualified as your principal residence for all the years you owned it, the entire gain is exempt from tax at the time of sale. You must report the sale of your principal residence on your personal tax return, even if the gain is exempt from tax. However, if you own a property and it was not designated as your principal residence, you may need to pay tax on any gain. This situation often arises when you own two properties, as only one can be designated as your principal residence.

Formula used by the CRA for calculating the principal residence capital gain exemption:

Exempt Gain=Total Gain X (YearsDesignated+1​) ÷ Total Years Owned

For example,

You bought a property in 2010 for $300,000 and sold it in 2024 for $500,000.

• Owned for 14 years (2010–2024).
• Designated as your principal residence for 10 of those years.

Step 1: Calculate total capital gain:

$500,000 − $300,000 = $200,000

Step 2: Apply formula:

Exempt Gain = 200,000 × (10 + 1) ÷ 14 = 200,000 × 11 ÷ 14 = 157,142.86

Step 3: Taxable gain:

200,000 − 157,142.86 = 42,857.14

Step 4: Apply capital gains inclusion rate (currently 50%):

Taxable Amount = 42,857.14 × 50% = 21,428.57

You would include $21,428.57 in your taxable income for that year.

Since 2016, If your sale your principal residence, you must report it on your T1 return even if all gains are tax exempt. If you do not report sales of your principal residence, the CRA may deny your exemption, resulting in tax on the gain. The CRA allows for late filing, but late filing penalties are applicable in this situation. The penalty for late filing is $100 per month up to a maximum of $8,000. Form T2091(IND) is used to designate a property as a principal residence, and the sale is reported on Schedule 3 of your T1 return. Reporting usually involves; year of acquisition, proceed of disposition and description of property (address).

What happens if you change your principal residence to a rental or rental property to a principal residence?

When you change your principal residence to rental property or rental property to principal residence, the CRA considers this as deemed disposition and capital gain or loss is calculated. Depending on your principal exemption, some or all of the gain on the deemed disposition may be taxable. The proceeds of disposition of a deemed disposition are the fair market value of the property at the time of change in use, which is used to calculate any gain, recapture, or terminal loss. Fair market value will be the cost for the next capital gain calculation at the time of eventual sale.

However, since there is no immediate cash flow from change in use and that may create financial burden on the taxpayer, CRA allows special election. This election allows you to elect not to have a deemed disposition at the time of change. This election allows you to claim principal residence exemption for additional four years even if you don’t live there. The summary of election is as follows:

1. From principal residence to rental
   1. Election can be made under subsection 45(2) – file this election by attaching singed letter to your tax return at the time of change in use.
   2. Allows you to designate your principal residence for additional four year.
   3. You cannot claim Capital Cost Allowance (CCA) on the property while it is rented out.
2. From rental to principal residence
   1. Election can be made under subsection 45(3) – file this election by attaching singed letter to your tax return at the time of change in use.
   2. Allows you to designate your principal residence for up to four years prior to moving in.
   3. You cannot claim Capital Cost Allowance (CCA) if you rented out partial units while living in

It is a good idea to consult a tax professional if you sell a principal residence in any tax year.

What are the tax consequences for the sale of personal used properties

The CRA categories personal property into two categories; personal- used property (PUP and listed personal property (LPP)

• Personal used properties (PUP): These properties are commonly used for personal use and enjoyment, such as vehicles, equipment, furniture, clothing and other household items.

If you sell these items, the following tax consequences may apply:

1. One-half of the gains are taxed
2. Capital losses on PUP are denied (i.e., cannot be claimed).

When calculating gain, if your cost of personal property is less than $1,000, The CRA deems the adjusted cost base (ACB) to be greater of original cost and $1,000. For example, if you sold furniture for $1,200 but originally paid $800 for it, your cost will be adjusted to $1,000, the greater of the original cost and $1,000—when calculating the gain. Therefore, you will pay tax only on $200 ($1,200 − $1,000), not on $400 ($1,200 − $800).

Listed personal property (LPP): This is a subset of PUP that includes certain collections which typically do not depreciate the value. According to Income Tax Act, LPP includes the following:

• Prints, etchings, drawings, paintings, and sculptures – essentially, works of art.
• Jewelry – including precious metals and stones set in items for personal wear.
• Rare folios, rare manuscripts, or rare books – items that are valuable due to age, scarcity, or historical significance.
• Stamps – collectible postage or revenue stamps.
• Coins – collectible coins, often made of precious metals or historically rare.

Since LPP typically do not depreciate value, the CRA has special rules regarding losses. However, same rule applies to the gain as for PUP. If there is a loss on sale of LPP, one- half of the loss may be deductible against capital gains realized on the disposition of LPP. Capital losses on LPP can only be applied against capital gain on LPP. To the extent that LPP losses exceed capital gains in a year, the excess losses can be carried back three years or carried forward seven years.