Capital gains taxes are a fact of life for every investor, including those who choose to make their commitments in the real estate sector. Sooner or later, every real estate investor in Canada is going to encounter this particular type of tax. It’s in your best interest to be an informed taxpayer when figuring out how you want to address these payments. There are some strategies that you can keep in mind while developing an approach, and we are pleased to present a brief primer on what you need to know capital gains taxes and how you can adjust to prepare for them.
Table of Contents - What You Need to Know About Capital Gains Tax (And How it Affects Your Real Estate Investment)
What are capital gains taxes?
Before we get into more detail, it’s important to understand exactly what capital gains taxes are. In Canada, this tax is applied to capital property (investments that would not count as part of a business inventory and that may qualify as a capital gain or loss) that is sold for more than what the investor paid for it. The Canada Revenue Agency (CRA) applies the capital gains tax on 50 percent of the capital gain amount, which is the difference in what you paid for the investment versus what you got for it.
It’s important to remember the difference between realized and unrealized capital gains. Unrealized gains are on investments that you haven’t sold, so they exist only on paper. Realized gains are what you make when you sell the investments. Realized gains are the gains that are subject to taxes.
One other thing to keep in mind is that the Canadian tax code does not require capital gains taxes to be paid on your principal residence. If you sell a house that was your principal residence for the entirety of the period in which you owned it, your only obligation is to report it on Form T2091 on your tax return and claim the full principal residence exemption at that time and you’re all set. If your principal residence was also generating income for you, things get a bit more complicated and you may owe capital gains taxes at tax time.
How do I calculate capital gains taxes?
Calculating capital gains taxes will require some math. Let’s go through an example that uses round numbers, just to keep things tidy and simple.
If you buy a property for $100,000 and sell it for $200,000, you have made a capital gain of $100,000. Now, as we discussed above, in the Canadian tax code this means that only 50 percent of your gains are taxable. So, $50,000 of that $100,000 is subject to capital gains taxes. This number will then be taxed according to your situation, which includes several factors as with all tax situations. Your capital gains are typically added to your annual income, and then taxed accordingly at the marginal rates that your income dictates.
These variables may include but are not limited to, your province and what your annual income is. There are calculators freely available online to help you get a start on this math. If you’re uncertain about your situation, it’s best to contact a tax professional who can help you navigate your financial situation.
How can I avoid capital gains taxes?
If you so choose, there are quite a few ways in which a person or household can soften the blow that capital gains taxes present at tax time. First, you are allowed to have capital losses offset capital gains. If you sold a piece of property for again but also had a bad year in the stock market (or sold a property for less than you paid) then those losses have a bright side – they can be used to reduce your overall capital gains tax burden. Not an ideal scenario, but it does allow you some breathing room at tax time.
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You can also consider using a tax-advantaged account if you want to lessen the amount of capital gains taxes.
Tax-loss harvesting is another strategy. You are capitalizing on the scenario outlined in the previous paragraph to maximize your losses. This can come in the form of selling off investments that took a loss, like low-performing stocks or properties that depreciated over the past year. You want to be careful to do this properly, as it can cause the CRA concern if you sell these assets and then buy them back a few days later. Consult a tax professional if you want to explore this route.
You can also donate assets to charity to reduce capital gains taxes. These can come in the form of cash or an in-kind donation such as donating stock or other investments to a charity of your choice. You will receive a tax receipt that reflects the current fair market value but, as always, we recommend you contact a tax professional first. This route gives you the chance to reduce taxes in a meaningful way that can also let you benefit a cause that is important to you.
This brief guide is only meant to serve as a starting point for your reading. It should also be noted that these taxes are necessary to fund vital services across Canada and help your local communities, so they are not something to shy away from. That said, it’s very possible to explore routes that lessen your burden, like the ones suggested above.
Capital gains taxes in Canada are something that every real estate investor is going to run into at some point in their career. They can be easily tackled if you do the proper research ahead of time. If you are interested in learning more capital gains taxes and how they might affect your real estate investment portfolio, get in touch with a qualified tax professional who knows the lay of the land.
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