Capital Gains Tax in Canada
You realize a capital gain when you sell a capital asset and the proceeds of disposition exceeds the adjusted cost base. Capital assets subject to this tax, according to the Canada Revenue Agency, include buildings, land, shares, bonds, and real estate investment trust units.
The proceeds of disposition is what you sold your capital property for, less any outlays and expenses of selling. The adjusted cost base is what you paid to acquire the capital property, including any costs related to purchasing the capital property.
The capital gains inclusion rate is 50% in Canada, which means that you have to include 50% of your capital gains as income on your tax return. The inclusion rate for personal and business income is 100%, meaning you need to pay taxes on all of your income. WOWA calculates your average capital gains tax rate by dividing your capital gains tax by your total capital gains.
Proceeds of Disposition
Proceeds of Disposition is what you have earned when you sell your capital property. Outlays and Expenses are the costs of selling and these may be deducted from the Proceeds of Disposition. For instance, if you sell financial instruments such as shares in a company, the trading fees you incur will be deducted from what you sold the shares for to get the Proceeds of Disposition on the stock. For real estate, Common Outlays and Expenses include costs of selling a house such as real estate commissions, lawyer fees and legal fees. If your proceeds of disposition is in a foreign currency, convert the foreign proceeds to Canadian dollars using the Bank of Canada daily exchange rate on the date you sold the capital property.
Capital Gains Tax Calculation
Proceeds of Disposition – Adjusted Cost Base = Total Capital Gain
Total Capital Gain * 50% Inclusion Rate = Taxable Capital Gain
Taxable Capital Gain * Marginal Income Tax Rate = Capital Gain Tax
The adjusted cost base is what you paid to acquire the capital property, including any costs related to purchasing the capital property. The capital gains inclusion rate is 50% in Canada, which means that you have to include 50% of your capital gains as income on your tax return
Capital Gains Tax on Sale of Property
Real estate property includes residential properties, vacant land, rental property, farm property, and commercial land and buildings. If you have sold real estate property, you will have to report any capital gains or losses on Schedule 3, the capital gains and losses form. If you sold both the property along with the land it sits on, you must determine how the sale price is distributed between the land and the building and report them separately on the Tax Form Schedule 3.
For example, you just sold a property for proceeds of disposition less outlays and expenses of $500,000. The Municipal Property Assessment Corporation (MPAC) appraised the land at $125,000, meaning that the land is worth 25% of the property value. Your adjusted cost base was $400,000, so your total capital gains is $100,000, and your taxable capital gains is 50% of that, or $50,000. The taxable capital gain for the land would be $12,500 and the taxable capital gain for the building would be $37,500. However, if the government suspects the property is used for business purposes, the tax will be paid on business income rather than capital gain. This increases the inclusion rate to 100%.
Principal Residence Exemption
When you sell real estate property, you may be exempt from paying capital gain tax if the property was your principal residence. You are only allowed to have one principal residence at a time, and if you have a spouse there can only be one principal residence for both of you. Additionally, the 2022 budget announcement proposes to terminate the principal residence exemption for Canadians who sell their home within 12 months of the purchase date. However, exemptions apply such as death, disability, the birth of a child, a new job or divorce.
The principal residence exemption only applies for Canadian residents. You will still have to report the sale of the property on Schedule 3. The tax will then be deducted when you fill out Form T2091(IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust), a separate form that designates the property as your past principal residence.
During your time of ownership, if there was a period where the property was not your principal residence, then you will not be able to receive the full amount of tax exemption. Instead, the exemption will be calculated based on the number of years that you held the property as your principal residence.
If part of your home was used as a principal residence and part of your home was used to generate income, you are required to distribute the ACB and the sale price between the two parts. For example, if 40% of your home was rented out to a tenant and 60% was designated as your principal residence, the principal residence exemption will only apply to 60% of the ACB and sale price.
If you held ownership of the property for 10 years, and it was rented out for 4 years, you would input 6 years into line 3 on Form T2091(IND) and complete the calculation in Part 1 to calculate your principal residence exemption.
In some cases, you can maintain the principal residence exemption while renting units in your principal residence. However, for this to qualify, you must meet all of the following criteria as outlined by the CRA.
- The rental use of the property must be small in comparison to its use as a principal residence.
- You must not make structural changes for rental purposes.
- You don’t deduct any Capital Cost Allowance from your rental unit portion.
What is a Principal Residence?
Your principal residence is where you and your family normally live in Canada during the year. You must own or jointly own the home. However, in some cases, a vacation property that you own and only you and close relatives use may be considered as your principal residence as long as you don’t earn any rental income from it. You don’t even have to live in the residence for the whole year. However, you can only claim one home as a principal residence in any calendar year for your family unit (you, your partner and any children under 18 years of age).
Your principal residence can be any number of different property types according to the Canada Revenue Agency. It can be a house, a duplex, a condo, a cottage, a cabin, a mobile home, a trailer or a houseboat. You can generally only have half a hectare (1.25 acres) of land on which your residence sits. However, there are exceptions to this. For instance, if the municipality you bought your property in has a minimum lot size that is already greater than half a hectare, then you may prove the increased lot size is solely for enjoyment purposes.
When selling a property that is not a principal residence, including a second home or investment property, you will have to pay capital gains tax. There are a few ways to reduce your capital gains tax.
You may be able to designate your second home as your principal residence by making an election to change your principal residence. There is a 4-year limit on designating your second home as a principal residence; however, this may be extended indefinitely if you or your spouse can prove the second home is being used for work-related reasons, such as your employer asking you to relocate. You will then qualify for the principal residence tax exemption and won’t have to pay capital gains tax. If you rent out your second home, however, it cannot qualify as a principal residence. It’s more complicated if you’ve only rented it out for part of the time you’ve held it. You may be able to claim the property as your principal residence for the time when you were using it. If so, you will not have to pay capital gains tax on the appreciation during that time. The CRA considers the total appreciation to be evenly spread over the time you have held the property.