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Tax time can be a stressful period for any real estate investor. Getting your paperwork in order and making sure that you have the cash reserves to pay any outstanding debts: it can all add up to a lot of strain. Many people simply hire professionals to handle this work for them, but that should not be the end of your responsibilities.
Every taxpayer has the right and the duty to look at ways to minimize the tax burden on themselves. There are all sorts of strategies and tactics to accomplish this, but one simple step to take is to look at your investments. Capital gains taxes can really take a bite out of your income, so devising strategies to lessen them can really pay dividends throughout the year.
Capital gains 101
Capital gains taxes are a complex concept, but they can basically be boiled down to this – you accrue a capital gain when a real asset that you own appreciates in value. A real asset is something tangible – think art, collectibles, real estate, land or stocks in a company. The idea behind capital gains taxes is that you ideally want to incentivize people to invest over the long term, rather than the short, which leads to more economic sustainability and stability.
In Canada, you owe capital gains taxes when you sell an asset for more than you paid – but only on half of the profit. If you paid $100,000 for a house and then sold it for $200,000, you would only owe capital gains taxes on $50,000. What you owe becomes a bit more complex – it all depends on your income, personal situation and which province that you call home.
Capital gains taxes can get quite complicated, but there are many completely legal ways that you can avoid bearing the full brunt of them.
Capital Gains Tax Saving Strategy 1: Create deductions
This strategy is based on a simple principle – if you don’t have capital gains, then you won’t owe taxes on them! While this sounds counterintuitive, you’re only creating enough losses to offset the tax bill. You can easily do this by selling stocks or other items at a loss – you can use these losses to reduce your overall capital gains and thus your tax bill.
There are some caveats here – you cannot manufacture a loss out of thin air. Anything that you sell must be sold for fair market value, which helps keep things fair and prevents the handshake deals that cost us all tax revenue. You also cannot sell assets in a registered account (think RRSP, RESP, etc.) and expect to receive an offsetting loss.
Finally, you can even utilize tax sheltering tactics – if you sell a large asset and then use the proceeds to contribute to an RRSP, you get a tax rebate that can offset the money owed on the gains. This can get complex, so it’s best to consult with a financial professional or accountant before attempting anything along these lines.
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Capital Gains Tax Saving Strategy 2: Get charitable
This one is one of our favourites since it provides a social good while also reducing your tax bill. Charitable donations in the form of stocks are not subject to capital gains taxes. This means that if you buy $500 worth of stock and it grows in value to $1,000, you would theoretically owe $250 in profits if you sold the $1,000. A charitable donation doesn’t work like this – you will have no tax liability as a reward for passing along this wealth to a non-profit entity.
One thing to note here is that you might think you could transfer assets to family members and not owe any tax. This, however, is not the case. If you gifted something like a house or a car to a child of yours you would owe tax – unless, of course, the asset had depreciated. If the house had fallen into disrepair, for example, and you could back your claim with evidence, you would not wind up owing tax on the transaction.
Capital Gains Tax Saving Strategy 3: Defer your earnings
One detail about capital gains taxes to keep in mind is that you only owe tax on the money that you receive. This benefit means that you can get creative and stagger your earnings over the years, leading to a reduced bill.
One way to do this is by asking the buyer of your real asset to break up the payments over several years, rather than paying everything all at once. If you sell your home for a $200,000 profit, you could ask the buyer to give you $50,000 a year for four years – this reduces your annual income and lessens the hit at tax time.
This strategy is not without limitations – you have to include at least 20 percent of the income each year, and this deferral can only be claimed for up to five years maximum.
Don’t get too “creative”
Real estate investors can get in trouble when they try to push the limits. A common scheme is to call a property a principal residence when it isn’t. The CRA is wise to these types of plans and will come after you if they believe that you’ve violated their regulations to create an unfairly advantageous tax situation for yourself.
You should also be clear about what kind of business you have. If you’re investing in a property with a plan to use it as a short-term rental (think Airbnb), income that results from those rentals will be taxed at the income level, not at the capital gains level.
Tax time can be a confusing period for real estate investors with a lot of irons in the fire but rest assured that strategies exist to save you money in both the short and long term. Working with a financial professional is the best way to be sure you’re doing everything by the book and are avoiding costly penalties, but it’s very helpful to do some basic research on your own before entering these conversations.