Introduction
In a move to create a more equitable tax system, the Canadian government has introduced significant changes to the Capital Gains Inclusion Rate, effective June 25, 2024. This revision, announced in the 2024 budget, impacts how capital gains are taxed and alters the treatment of capital losses.
The New Capital Gains Inclusion Rate
Previously, 50% of capital gains were taxable, meaning only half of your capital gains were included in your income. However, under the new legislation, the maximum inclusion rate has increased to two-thirds, or 66.67%, for all transactions occurring after June 25, 2024.
This change affects not just real estate transactions but also other capital assets like shares, art, and collectibles. For individuals, the first $250,000 in annual capital gains remains subject to the previous 50% inclusion rate, but any gains exceeding this threshold will be taxed at the new, higher rate.
Example
Scenario:
You sell a property on July 1, 2024, and realize a capital gain of $500,000.
Old Rule:
Under the old rule, 50% of the capital gain would be included in your taxable income.
Taxable income: $500,000 x 50% = $250,000.
New Rule:
Under the new rule, the first $250,000 of the gain is still taxed at the 50% rate, but the remaining $250,000 is taxed at the new rate of 66.67%.
Taxable income: ($250,000 x 50%) + ($250,000 x 66.67%) = $125,000 + $166,675 = $291,675.
Impact:
The increase in the inclusion rate results in an additional $41,675 being added to your taxable income under the new rule.
For corporations and trusts, the $250,000 threshold does not apply. A flat rate of 66.7% is applied to capital gains. The new rules affect not only how much more capital gain income businesses have to report but also the regular active business income. The Small Business Deduction (SBD) shrinks faster under the new rules. SBD allows CCPCs to enjoy a lower tax rate (12.2% in Ontario) on up to $500,000 of active business income each year, known as the “business limit.”
However, the business limit gradually decreases if the CCPC and its related companies have “adjusted aggregate investment income” (which includes passive income like rent, dividends, interest, and taxable capital gains) between $50,000 and $150,000. With a higher capital gains inclusion rate, the corporation’s aggregate investment income will increase even with the same amount of capital gains.
Capital Loss Treatment Under the New Rules
The treatment of capital losses has also been adjusted to reflect the updated inclusion rate. If you incurred a capital loss before June 25, 2024, that loss can still be carried forward or back to offset future capital gains, but the application becomes more complex under the new system.
For instance, if you had a $300,000 capital loss before the rule change, with a 50% inclusion rate, your net capital loss would be $150,000. This loss can be applied against future capital gains, but the calculation must now consider the new inclusion rate for gains exceeding $250,000. The government has emphasized that these losses will be adjusted appropriately, ensuring that taxpayers are not disadvantaged by the rule change.
Vendor Take-Back Mortgages and Capital Gain Reserves
For those using vendor take-back mortgages, where payments for a property sale are received over several years, the new inclusion rate adds another layer of complexity. It is important to note that the inclusion rate applies based on when the gain is recognized, not when the sale occurred. Therefore, taxpayers might consider structuring new payment plans to benefit from the lower inclusion rate.
The Good News
- Principal Residence Exemption: Capital gains from selling your primary residence remain exempt from taxation.
- Lifetime Capital Gains Exemption (LCGE): The exemption for small business owners has increased to $1.25 million.
Conclusion
The increase in the Capital Gains Inclusion Rate marks a significant shift in Canada’s tax policy. It is essential for individuals, corporations, and trusts to understand these changes and adjust their tax planning strategies accordingly. As always, consulting with a tax professional is advisable to navigate these new rules and minimize tax liabilities effectively.
For more information regarding the new capital gain inclusion rules, please check CRA web page.