Taxes on Capital Gains

When capital property, such as shares in a public or private company, is sold for an amount in excess of what was paid for it, this gain will be subject to what is commonly referred to as capital gains tax. However, not all of the gain is subject to tax. The taxable portion of the capital gain is equal to one-half of the gain. The best way to demonstrate the calculation of the tax on capital gains is to look at an example:

Mr. Smith buys 1,000 shares of TD Bank for $50,000. The purchase price of $50,000 represents his adjusted cost base. Mr. Smith subsequently sells those shares for proceeds of $100,000. This disposition would result in Mr. Smith having a $50,000 capital gain, representing the difference between his sale price and the adjusted cost base. However, only one-half of the $50,000 gain ($25,000) needs to be taken into his income for tax purposes.  This is known as the taxable capital gain.  A general formula to determine the amount of taxes that will be payable on a capital gain is as follows:

(Capital gain X 50%) X the taxpayer’s marginal tax rate = tax payable on the capital gain

Not all sales will result in a taxable capital gain.  If a person sells property for an amount less that its adjusted cost base, this will result in a capital loss.. Any capital losses incurred during the year can be used to offset or reduce capital gains in the same year. Net capital losses (one-half of the capital losses in a year) can also be carried back to offset taxable capital gains in the three preceding taxation years, and carried forward to offset  future taxable capital gains without any time limit.

If in the same year Mr. Smith bought 1,000 shares of Royal Bank for $50,000 and sold them for $40,000, he will incur a capital loss of $10,000. As such, assuming the only capital property Mr. Smith sold in the year were the TD Bank and Royal Bank shares, Mr. Smith’s gain for the year would be:

$50,000 (capital gain) -$10,000 (capital loss) = $40,000 capital gain

$40,000 x 50% = $20,000 taxable capital gain

In Canada, an individual is also deemed to have disposed of all capital property owned immediately before death at fair market value (subject to several exceptions).  What this means is that when a person dies, their shares, real estate and other capital property are treated as if they were sold for fair market value and tax will be payable on any resulting capital gains.  However, if the property is transferred as a result of death to a spouse/ common-law partner or a specific type of trust for a spouse/common-law partner, the disposition can take place at the adjusted cost base of the property and any capital gains will be deferred until a later disposition by the spouse/common-law partner.  People often undertake different  strategies to reduce, defer or fund this tax, which are explored in more detail in in the trust, estate planning, and life insurance sections.