Understanding Capital Gains and Losses for Individuals and Business Owners

Taxes can feel overwhelming, but breaking them into simple concepts makes them easier to manage. Capital gains taxes, which apply when you profit from selling investments, are particularly important to understand. In 2024, new rules in Canada added complexities to how capital gains are taxed. Let’s walk through the details, step by step, and explain how individuals and businesses can handle these changes effectively.

What Are Capital Gains and Losses?

A capital gain occurs when you sell an asset—such as stocks, real estate, or mutual funds—for more than what you paid for it. A capital loss happens when you sell an asset for less than its purchase price.

Examples of Gains and Losses

1. Capital Gain Example:
   You buy a stock for $100 and sell it for $150. The $50 profit is your capital gain.
2. Capital Loss Example:
   You buy a stock for $100 and sell it for $80. The $20 difference is your capital loss.

If you hold onto an asset and its value changes without selling, the gain or loss is “unrealized,” meaning it’s not taxable. Taxes only apply when the asset is sold, and the gain or loss is “realized.”

Understanding the 2024 Capital Gains Inclusion Rate

Canada’s 2024 tax rules introduce a tiered system for taxing capital gains, where the portion of your gains subject to tax depends on how much you earned.

How the Inclusion Rate Works

1. For Gains Under $250,000:
   The inclusion rate is 50%, meaning only half of the profit is added to your taxable income.
   Example: If you earn $200,000 in gains, only $100,000 is taxable.
2. For Gains Over $250,000:
   The portion of your gains exceeding $250,000 is taxed at a higher 66% inclusion rate.
   Example:
   • You earn $300,000 in gains.
   • The first $250,000 is taxed at 50%, so $125,000 is taxable.
   • The remaining $50,000 is taxed at 66%, so $33,000 is taxable.
   • Total taxable income = $125,000 + $33,000 = $158,000.

How to Calculate Your Capital Gains or Losses

The formula for calculating capital gains is straightforward:

Capital Gain = Proceeds of Disposition – Adjusted Cost Base (ACB)

• Proceeds of Disposition: The money you receive from selling an asset.
• Adjusted Cost Base (ACB): The original purchase price of the asset, plus any expenses related to acquiring it (e.g., legal fees, commissions).

Example Calculation

• You sell a property for $500,000.
• You originally bought it for $400,000 and spent $10,000 on legal fees.
• Your ACB is $400,000 + $10,000 = $410,000.
• Your capital gain is $500,000 – $410,000 = $90,000.

How Capital Losses Can Reduce Taxes

Capital losses are valuable because they can reduce the amount of tax you pay on your gains. Here’s how you can use them:

1. Carry Back:
   Apply losses to offset gains from the past three years. This can result in a refund for taxes already paid.
2. Carry Forward:
   Save losses to use in future years, even decades later, to offset future gains.
3. Apply in the Current Year:
   Use losses to directly reduce the taxable portion of your current year’s gains.

If your gains were taxed at different inclusion rates (e.g., 50% vs. 66%), losses are averaged accordingly to ensure fair tax treatment.

Capital Gains for Corporations

For businesses, capital gains are taxed differently than for individuals. The taxable portion of the gain depends on the inclusion rate, and corporations can use special tools like the Capital Dividend Account (CDA) and Refundable Dividend Tax on Hand (RDTOH) to manage taxes efficiently.

Corporate Capital Gains Example

Let’s walk through a full example of how a corporation handles capital gains:

Scenario

A corporation sells an investment property for $1,000,000. The property was originally purchased for $700,000, and $20,000 was spent on legal fees during the purchase.

Step 1: Calculate the Capital Gain

1. Proceeds of Disposition: $1,000,000 (sale price).
2. Adjusted Cost Base (ACB): $700,000 (purchase price) + $20,000 (legal fees) = $720,000.
3. Capital Gain: $1,000,000 – $720,000 = $280,000.

Step 2: Determine the Taxable Portion

1. The inclusion rate for 2024 is 66%.
2. Taxable Capital Gain: 66% × $280,000 = $184,800.
3. The corporation adds $184,800 to its taxable income and pays tax at the corporate investment income rate (which varies by province).

What Is the Capital Dividend Account (CDA)?

The CDA allows corporations to distribute the non-taxable portion of a capital gain to shareholders tax-free. This ensures that shareholders can benefit from the tax advantages of capital gains.

How It Works

1. The non-taxable portion of the gain is added to the CDA.
   Non-taxable portion = (1 – inclusion rate) × capital gain.
   For the $280,000 gain: (1 – 66%) × $280,000 = 34% × $280,000 = $95,200.
2. The corporation can pay the $95,200 to shareholders as a tax-free capital dividend.

This system ensures that shareholders don’t pay tax again on the non-taxable portion of the gain.

What Is Refundable Dividend Tax on Hand (RDTOH)?

The RDTOH is a mechanism that ensures a corporation can recover some of the tax it pays on investment income (including taxable capital gains) when it distributes dividends to shareholders. Without this, the same income could be taxed twice: once at the corporate level and again at the personal level.

How It Works

1. When a corporation pays tax on taxable capital gains, a portion of that tax is added to the RDTOH account.
2. When the corporation distributes dividends to shareholders, it can recover some of the tax paid.

Example Refund

• A corporation distributes $1 of taxable dividends.
• It recovers $0.38 from the RDTOH account for every dollar of dividends paid (rates vary by province).

This ensures efficient tax treatment when profits are distributed.

Why You Should Work with a Financial Advisor

Navigating corporate tax rules and tools like the CDA and RDTOH can be complex, especially when combined with personal capital gains taxes. A financial advisor can help you:

• Time asset sales to minimize taxes.
• Use the CDA and RDTOH effectively.
• Optimize your corporate and personal finances for maximum after-tax returns.

Conclusion

Understanding capital gains taxes in 2024 is essential for both individuals and businesses. The tiered inclusion rates for personal gains and tools like the CDA and RDTOH for corporations offer opportunities to reduce tax burdens but require careful planning. By working with a financial advisor, you can create a strategy that protects your wealth and ensures you pay no more tax than necessary.