Changes to the capital gains tax—what could they mean for you?

The 2024 federal budget proposed to increase the taxable portion on capital gains higher than $250,000 per year for individuals, and on all capital gains for corporations and most types of trusts. These changes came into effect on June 25, 2024.

What are capital gains and how are they taxed?

A capital gain is the profit you make selling certain types of assets, such as stocks, bonds, shares in mutual funds, a secondary property, such as a cottage, rental or investment property, and business assets, such as buildings or equipment.

In simple terms, if you sell the asset for more than you paid for it, the difference is the capital gain. If you sell it for less than you paid for it, the difference is a capital loss. For example, if you bought an asset for $100,000 and sold it for $500,000, your capital gain would be $400,000.

When you realize capital gains, a percentage—called the inclusion rate—determines the amount that gets added to your income for the year, which is then taxed based on your marginal tax rate. 

For capital gains realized before June 25, 2024, that inclusion rate is 50%, which means that on a capital gain of $400,000, your taxable portion would be $200,000.

What’s changing?

Starting June 25, 2024, the capital gains inclusion rate will be 2/3 or 66.67% for capital gains of over $250,000 per year for individuals, and for all capital gains for corporations and most types of trusts. This means:

If you’re an individual who makes more than $250,000 in capital gains in a year, the inclusion rate will be 50% for the first $250,000, and 66.67% for any amount above that. For example, if you realize $400,000 in capital gains the taxable portion will be calculated as follows:

• 50% inclusion rate on the first $250,000, or $125,000
• 66.67% inclusion rate on the next $150,000, or $100,000
• The total to be added to your taxable income will be $225,000

If you own an incorporated business and you sell assets or investments that you hold in your business, the inclusion rate on those capital gains will be 66.67% on the full amount. On a capital gain of $400,000 this would mean that $266,667 would be taxable.

What could this mean for your retirement planning?

If you realize less than $250,000 in capital gains in a year, the new rules won’t change anything for you. This is expected to be the case for most Canadians.

However, there are situations and one-time events that can trigger substantial capital gains, such as the sale of a cottage or a business, or the death of an individual. As the new rules come into effect on June 25, 2024, it’s important to understand how they may apply in your case, what exemptions are available, and the impact on your long-term retirement plans.

Your retirement savings, income, and investments

If you have money saved for retirement, or you’re receiving a retirement income, here’s how the new rules will apply:

• What’s exempt—There’s no tax on capital gains realized from investments in tax-deferred or tax-sheltered registered plans such as RRSPs, RRIFs, RPPs or TFSA plans. . The new rules also won’t change anything about how withdrawals from those plans are taxed.
• What’s taxable—Earnings from investments you hold in a non-registered account are taxable, so the new inclusion rates will apply to capital gains on assets held in these accounts. Remember that to the extent your capital gains for the year are less than $250,000, the 50% inclusion rate will continue to apply.

Selling your property

If you’re planning to sell real property and use the proceeds to help fund your retirement, here’s how the new rules will apply:

• What’s exempt—There’s no capital gains tax if you’re selling your principal residence.
• What’s taxable—If you sell a property other than your principal residence, such as a cottage, a rental property, or a piece of land, the new inclusion rates apply to any capital gains from the sale to the extent the gains exceed $250,000. This applies even if you gift a property, such as your family cottage.

Your estate planning

When a person dies, they are deemed to have disposed of all their capital property at fair market value immediately before death. Any capital gains resulting from this deemed disposition are taxable on their final tax return based on the applicable inclusion rates(s) and taxed based on their marginal tax rate. With the new inclusion rate rules, this could potentially result in a higher final tax bill than under the old rules.

If you own a small business

The new rules have raised concerns among entrepreneurs who invest in their business to help fund their retirement. However, two changes announced in the federal budget might provide some relief to some business owners:

1. An increase in the Lifetime Capital Gains Exemption (LCGE) to $1.25 million from the previous $1 million for business owners selling qualified small business corporation shares or qualified farm or fishing property.
2. A new phased Canada Entrepreneurs’ Incentive (CEI) may eventually provide up to $2 million of additional tax-free capital gains upon the sale of qualified small business shares by 2034. However, the CEI is not available to certain business sectors. 

Reminders about capital gains

Regardless of the size of the capital gains you realize, there things to keep in mind that may help reduce the amount of tax you pay on capital gains. Here are a few:

1. Capital gains or losses are equal to the proceeds less the adjusted cost base of the asset. Remember to  factor in all the eligible costs related to acquiring an asset, plus any outlays and expenses. This will help ensure you don’t over-state your capital gains.
2. If you have had capital losses in previous years you can use them to offset capital gains. You can generally apply net capital losses to taxable capital gains of the three preceding years and to any future years.
3. Where possible, consider planning the timing of dispositions of assets to help avoid exceeding the $250,000 threshold in a given year.
4. If you’re a business owner, check if you can use the LCGE and CEI.

What happens next?

The changes will affect some Canadians more than others, but if you own a cottage or a small business, or if you have a large estate, or anticipate realizing a large capital gain in future, consult your financial advisor and a tax specialist to review your retirement plans, your estate plan, and your tax strategy.

The federal government has introduced draft legislation to amend the Income Tax Act to reflect the the new capital gains inclusion rate rules. Regardless of when it becomes law, the changes take effect on June 25, 2024.