Canada taxes both income and capital gains, but the two are taxed differently. Capital gains and capital losses result from the disposition of capital property. The difference between capital property, inventory, and personal property is not covered in this article. As a general guide, property that is held as an investment to produce income, such as stocks, rental property, or bonds. Interestingly, a disposition includes a sale, but also includes other events such as a deemed sale, a gift, theft of property, or expropriation by government.
As already mentioned, capital property is taxed differently than income. For a number of policy reasons, taxable capital gains are half of the actual capital gain. This means that only half of the gain is taxed and the other half is received tax free. This is a large tax advantage. If, for example, you bought stock for $1,000 and the sold it for $10,000, the gain on the sale is $9,0000. Of the $9,000 gain, only half or $4,500 is taxable and the other $4,500 is received tax free. So, how does a taxpayer report their capital gains or losses to the Canada Revenue Agency (“CRA”)? The CRA has Form T4037 “Capital Gains” that is a partial guide for the most common issues and questions that a taxpayer may have when faced with reporting capital gains. This guide is lengthy despite it not being comprehensive.
For most people, cra capital gains and losses will be on information slips you are provided yearly, information slips you are provided yearly, including T3, 4PS, T5 and T5013. In other cases, your investment account history will provide you with the purchase and sale of securities that, if capital property, must be reported. For 2016, a few things have changed. The change that will affect almost every Canadian at some point is the reporting requirements for sales of principal residences. Before 2016, you didn’t have to report gains on sales of principal residences where you applied the principal residence exemption. After 2016, the gains on the sale of a principal residence are still tax free, but you have to report the gain to the CRA. You report your gains or losses from dispositions of capital property in the year you have disposed of the property. The reporting is one in your tax return and is due on the date your tax return is due. Schedule 3 of your T1 is where you show how you calculate your capital gains or capital losses for the year.
In order to report a capital gain or a loss, you have to know how to calculate it. There are two general components to the calculation. The first component refers to when you bought the property and is called the Adjusted Cost Base or ACB. This is the amount you paid to get the property. To this, you also add any cost or expenses that relate to your purchase of the property. Cost can include lawyer fees, commissions paid to brokers, and other costs related to you getting this property in your name.
The second is called the “proceeds of disposition” and refers to the amount you received when you sold the property. As with the ACB, you get to deduct any costs or expenses that relate to your disposition of the property. One note of caution. The proceeds of disposition is not always the amount you received on the disposition. If you have made a gift or property or sold property at a value other than fair market value to someone who is not at arm’s length (for example a relative) to you, then what you receive is not what you have to report. For example, where you have given property to a child, then even though you haven’t received any money from your child, the proceeds of disposition will be the fair market value of the property (unless an exception is available).
To get the capital gain or loss, you take the “proceeds of disposition” and deduct from this the ACB of the property. Where the number is positive, you have a capital gain. Where the number is negative, you have a capital loss. The taxable portion of the capital gain is 50% of the capital gain, and the allowable portion of the capital loss is 50% of the capital loss. You can carry back capital losses for three years and you can carry capital losses forward indefinitely.
There are a few exclusion where otherwise you would have to report and pay tax on gains. The most well known exception is the life-time capital gains exclusion for the sale of certain private company shares or for sale of farm or fishing properties. However, where you make a donation of certain properties to a charity (a qualified donee), you don’t have to include any amount at all. The donation of mutual fund stock, mutual fund trust units, interest in a segregated fund, ecologically sensitive land, and publicly traded shares or debt are the kinds of property where a donation won’t result in you having to pay tax on the gain.
This article is meant to introduce you to the reporting of capital gains and losses and provide some general information about capital gain. However, the devil is always in the details. The taxation of capital gains or losses, and the question of whether property is even capital property, can be very complex. Unless your case is one of the few that clearly falls into the capital gain bucket, it is best to contact a tax professional and make sure you are filing your taxes and reporting your gains correctly. This way you avoid penalties and taxes. If you have reported or think you have reported gains wrong in past years, you may be eligible to avoid penalties and interest by using the CRA’s Voluntary Disclosure Program. To see if you are eligible, contact Faris CPA.
