Taxes on Capital Gains

When capital property for example, shares in a public or private company or real estate (other than your principal residence) is sold for an amount in excess of what you paid for it, then this gain will be subject to tax which is known as capital gains tax. The cost of the capital property when it was purchased is the adjusted cost base of the capital asset. Not all of the gain is subject to tax. The taxable portion of the capital gain is one half of the gain. The best way to demonstrate the idea of capital gains is to look at an example:

Mr. Smith buys 1,000 shares of TD Bank for $50,000. The $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, one-half of the $50,000 gain ($25,000) is the taxable portion of the capital gain. Assuming that Mr. Smith is not an active and regular trader in stocks, Mr. Smith must include $25,000 as part of his total income for tax purposes. A very general formula to determine the taxes on a capital gain is as follows:

(Capital gain X 50%) X marginal tax rate = capital gain tax

Not all sales result in a gain, as sometimes a person will sell at a loss, which is referred to as capital losses. Any capital losses incurred during the year can offset or reduce capital gains in the same year. Net capital losses can also be carried back and offset against capital gains in the three preceding taxation years and carried forward and offset against future capital gains indefinitely. If Mr. Smith bought 1,000 shares of Royal Bank for $50,000 and sold them during the year for $40,000, he will have incurred a capital loss of $10,000. As such, Mr. Smith’s net capital gain for the year is:

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

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

In Canada, an individual is also subject to capital gains tax upon the “deemed disposition” of their assets on death. What this means is when a person dies, their shares, property, and other assets (other than a principle residence) are treated as if they were sold for fair market value. Unless the property is transferred to spouse (common-law partner) or a specific type of trust for a spouse (common-law partner), the capital gains tax will be applied to the extent of any capital gain realized from that deemed disposition. People undergo numerous strategies to pay this tax, which can be seen in the trust, estate planning, and life insurance sections.