Capital Gains: Calculating, Reporting, and Tax Planning Considerations
- Rylan Kaliel
- Apr 23
- 10 min read
Updated: Apr 27
Capital gains taxes are an important consideration for Canadian taxpayers investing in property, securities, or other assets. Understanding what capital gains are, how they’re calculated, and how they’re taxed is essential to effectively manage your investments and minimize your tax liabilities. This comprehensive blog post covers key aspects of capital gains, including calculating gains, reporting requirements, and practical tax planning strategies.
What is the Benefit of a Capital Gain or Loss?
The immediate benefit of having a capital gain is that only 50% of the income is taxable. This means that if you would normally pay $100 in tax, if it were a capital gain, you would only incur $50 of tax. As such, having something be treated as a capital gain is extremely valuable.
Capital losses on the other hand are not as favourable. First, only 50% of the loss is deductible. Second, capital losses can only be deducted against capital gains, which limits their deductibility. Any unused capital losses can be carried back to the three previous taxation years or forward indefinitely to be used against capital gains arising in those years.
What is a Capital Gain or Loss?
A capital gain/loss occurs when you sell a specific type of asset, known as capital property, such as stocks, bonds, mutual funds, real estate, or other investment properties. The difference between the sale price (proceeds of disposition or POD) and the purchase price (adjusted cost base or ACB), less any related selling expenses, determines your capital gain or loss.
There are a few key terms to understand as part of this.
Proceeds of Disposition (POD): The amount you receive when you sell the asset.
Adjusted Cost Base (ACB): The original purchase price, plus any related costs (e.g., brokerage fees, legal fees, or property transfer taxes).
Costs of Disposition (or selling expenses): Expenses directly related to selling the asset, such as real estate commissions or brokerage fees.
Capital gains arise when the POD, less any selling expenses, are greater than the ACB. Capital losses arise when the POD, less any selling expenses, are less than the ACB. The following will illustrate the calculations for a capital gain and a capital loss:
In example #1, we see that we have net POD in excess of the ACB, therefore we have a capital gain. Similarly, in example #2, we see that we have net POD less than the ACB, therefore we have a capital loss.
What is Capital Property?
Whether an asset is capital property or not is a question of facts and can be difficult to determine. Capital property is generally an asset that is held for longer periods of time, normally intended to be held for the benefits the asset can provide you during the time they are held. Thinking of this a different way, an investment in shares may be held to receive dividends from the corporation, this is a benefit that can be received during the time the shares are held. Alternatively, the purchase of a home for you to reside in would provide the benefits of being a residence for you. It is these benefits of holding the property that can dictate whether something is capital property or not.
Where this can get tricky is when there are not any explicit benefits during the time the asset is held. Think for example of shares of a tech startup which is losing a lot of money and not paying dividends, however, there is a promise that it will be worth something in the future. While the shares are not paying dividends right now, holding these shares would entitle you to larger dividends in the future when it is worth something. Typically, in these cases we would expect that these startup shares are still capital property.
This can be contrasted against other assets, such as cryptocurrency. Cryptocurrency generally does not pay a dividend and the value is in re-selling the asset later for a profit. As at the time of writing, the Canada Revenue Agency’s (CRA) view is that these are closer to inventory.
Inventory is typically the classification for an asset if it is not capital property, and generally refers to assets that are held for re-sale. This is the largest question to ask when reviewing if something is capital property, which is whether the asset is intended for re-sale or to be held for the inherent benefits the asset can provide.
The factors that are reviewed when looking at whether something is capital property would generally be:
Your intention with respect to the asset at the time of purchase: What is the goal of the purchased asset? To earn dividends or re-sale at a later date?
The feasibility of your intentions: Do you have the means to carry out the intended purpose? For example, if you purchase a house with the intention to rent, can you actually rent out the house? Are there potential tenants in the area that would be willing to rent out the house?
The extent to which you carried out the intentions: After the purchase, did you actually proceed with the intended purposes and how much effort was exerted to achieve these intentions? Following from the above example, did you actually follow through with attempting to find tenants and how much effort did you put towards finding a tenant?
The nature of the business you typically undertake: Would your ordinary business suggest that you intend to treat the purchase of an asset as inventory? For example, the purchase of a house by a realtor who has a habit of purchasing and re-selling homes may suggest that the purchase of a home may be inventory.
The length of time you held the asset: How long did you hold the asset and does this time appear to be similar to other assets that are capital property? If you held an asset for 3 months, this may suggest that the intention was to purchase and re-sell the asset, especially if most similar assets are held for a longer period of time.
The factors that motivated the sale of the asset: Were you motivated to sell because the price was high or due to other factors? Selling an asset because it could be sold for a higher price may suggest that the asset is inventory.
While the above is not an exhaustive list, these are key factors to consider when purchasing and selling assets that you would like to be treated as capital property. It is important that you document, at the very least, your intention and the feasibility of your intentions to support a later claim that the asset was capital property.
As a small note, there are some exceptions to these rules, such as with real estate. Generally, if real estate is sold within 365 days of purchase there are rules that default this to being treated as inventory and not capital property. As such, it is recommended that on the sale of assets, especially those with high values and/or those that you are expecting a larger capital gain or loss to arise that these be reviewed by a tax specialist to confirm the appropriate tax treatment.
Adjustments to the Adjusted Cost Base
Typically, the (ACB) is the cost that you pay to acquire an asset. Take for example, a rental property which was acquired for $550,000. The ACB for this property would be $550,000.
In addition to the amount paid for the asset, sometimes there can be increases or decreases to the ACB from the amount the asset was originally acquired for. In our previous blog on rental income, we noted one case, which is where there is non-deductible property tax and/or mortgage interest. In this case, the ACB of the land on the rental property would increase in an amount equal to the non-deductible property tax and mortgage interest.
A few of the more common increases to the ACB are as follows:
Capital improvements: Costs incurred the increase the value of an asset and/or better the asset (more on this below).
Property tax and mortgage interest on land: Costs incurred where rental income after all other expenses does not exceed these amounts, more on this in our blog on rental income.
Acquisition costs: Costs incurred as part of the acquisition of an asset, such as legal fees, commissions, and transfer taxes.
Capital contributions: Amounts contributed to a corporation where no shares are received, other than a loan.
A few of the more common decreases to the ACB are as follows:
Return of capital: Amounts withdrawn from the capital (equity) of the corporation.
Government assistance: Amounts received from the government to assist in the purchase of an asset.
There can be several other adjustments to the ACB that may be more niche or specific to certain industries. It is advised that amounts incurred in relation to assets be reviewed by a tax professional to ensure they are appropriately reported.
Capital Improvements
Capital improvements relate to amounts paid to improve capital property. The concept is that if an expenditure provides a lasting benefit, meaning that the expenditure is not short term in nature, it is instead a benefit that will last for several years, such as a new roof on a house. We would also look for expenditures that improve an asset beyond its original condition, such as installing a wheelchair ramp to a place of business.
When an expense is a capital expenditure, these amounts are generally not immediately deductible for tax purposes. Instead, they are added to the ACB of the asset. If the asset is a depreciable property, meaning that this can be deducted as capital cost allowance (CCA) over time (brief comments on CCA are included in our blog on rental income).
It is important to consider expenses incurred in relation to a capital property to determine if they are capital improvements. Where these are incurred, you should track the amounts and ensure you have an up-to-date ACB calculation that includes these amounts.
What are Taxable Capital Gains and Allowable Capital Losses?
As noted above, when we have a capital gain or loss, only 50% of the amount is taxable/deductible. When we apply this 50%, the result is our taxable capital gain or allowable capital loss. Put simply, they could be defined as follows:
Taxable capital gain: Capital gain x 50%
Allowable capital loss: Capital loss x 50%
The rationale for using different words is an attempt to be clear about whether we are talking about the full gain or loss or the taxable/deductible gain or loss. When we refer to taxable capital gains or allowable capital losses, we are referring to the amount that is included in taxable income.
See the below example for an illustration of how taxable capital gains and allowable capital losses are calculated.
As we can see, both take the capital gain or loss and multiply this by 50% to get the ending taxable (allowable) capital gain (loss). In example #1, as we had a positive number, or a capital gain, we would have a taxable capital gain of $95. In example #2, as we had a negative number, or a capital low, we would have an allowable capital loss of $155.
Calculating Taxable Capital Gains and Allowable Capital Losses
As was discussed above, we would first need to determine or capital gain or loss. We would calculate this as follows:
Capital Gain (Loss) = Proceeds of Disposition – Costs of Disposition – Adjusted Cost BaseTo calculate the taxable capital gain or allowable capital loss, we would multiply these amounts by 50%, which could be calculated as follows:
Taxable (Allowable) Capital Gain (Loss) = Capital Gain (Loss) x 50%One thing to note, the 50% is the current rate to be applied to capital gains or losses. This rate is subject to change, in fact, shortly before the writing of this blog there was a rate change that was set to increase the rate to 2/3 or 66.67%. This rate change has since been cancelled, and we will remain at 50% until further notice.
Example of a Capital Gain Calculation
If you purchased shares for $5,000 (ACB), paid $50 in brokerage fees (increasing your ACB to $5,050), and later sold them for $7,000 with selling costs of $50, your calculation would be as follows:
Reporting Capital Gains on Your Tax Return
Capital gains and losses must be reported on Schedule 3 Capital Gains or Losses of your personal tax return. Accurate record-keeping, including receipts, invoices, brokerage statements, and other documentation, is essential to support your reported amounts.
Principal Residence Exemption
If the asset sold is your principal residence, you may qualify for the principal residence exemption, potentially eliminating taxes on the capital gain. However, certain rules apply:
You must ordinarily reside in the property.
Only one property per family unit can qualify as a principal residence in any given year.
Special considerations apply if the property was partially rented or used for business purposes.
Where you are eligible for the principal residence exemption, this could completely eliminate any capital gains tax arising on the sale of a principal residence. It should be noted that careful planning is required to optimize this exemption and as such consultations with a tax professional are recommended. The details of the principal residence exemption will be discussed in more detail in an upcoming blog post.
Tax Planning Considerations for Capital Gains
Effective tax planning can significantly impact your capital gains tax liability:
Timing of Sales: Strategically time asset sales to manage tax brackets or offset capital losses.
Utilizing Losses: Realize capital losses strategically to offset taxable capital gains.
Gifting Assets: Consider gifting appreciated assets to family members in lower tax brackets (while mindful of attribution and gifting rules).
Charitable Donations: Donate appreciated assets directly to registered charities to eliminate capital gains tax on those assets, note this may only apply to specific types of assets.
Deferral Strategies: Have assets owned in your RRSPs and TFSAs to trigger gains without immediate tax consequences.
Certain tax planning strategies require careful implementation and documentation and can be challenging to carry out correctly. It is advised that you discuss the above planning considerations with a tax professional to ensure they are structured correctly.
Common Pitfalls to Avoid
Avoid common errors related to capital gains:
Incomplete Reporting: Failure to report capital gains or losses accurately.
Misunderstanding ACB: Incorrectly calculating or omitting adjustments to the ACB.
Ignoring Foreign Assets: Not reporting capital gains on foreign assets or neglecting related foreign tax implications.
Consulting with a tax professional can help you navigate these complexities effectively.
Summary
Understanding capital gains taxation, calculation methods, and effective planning strategies enables you to optimize your tax outcomes. Accurate reporting and strategic decision-making can help you manage your investment portfolio efficiently and minimize your overall tax burden.
Stay tuned for our next blog, where we'll delve into retirement income and related taxation considerations. KLV Accounting is here to help. Contact us today to enhance your financial strategy and drive business success!
For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.
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