What is Capital Gains Tax?
Capital Gains tax is a tax rate that is applied to income earned from the sale of capital property. This differs from the tax rate that is applied when you earn regular income.
How do I determine Capital Gains Tax?
In order to determine if a transaction will be subject to capital gains tax, a taxpayer needs to determine if the transaction is a transaction of capital property. A capital gain or capital loss usually arises upon a transaction of capital property.
What is a Capital Property?
Capital property is any property that results in a capital gain or capital loss. It usually includes property purchased as an investment, or property purchased to earn income. Examples include real estate property, securities, or equipment used in a business. Capital property does not include trading business assets, such as inventory.
Further examples of capital property transactions resulting in a capital gain or capital loss include gifts and exchanges of property, expropriation, theft, or destruction of property, or changing all or part of the property’s use.
When to Claim Capital Gains or Losses?
Upon making a transaction in capital property, a taxpayer must report the disposition of the property in the calendar year of disposition. The disposition must be reported regardless of whether it results in a capital gain or capital loss.
How do I calculate Capital Gains or Losses?
To calculate the amount of a capital gain or capital loss, a taxpayer must determine the dollar amounts of: the proceeds of disposition, the original purchase price of the property (“adjusted cost base”), and any outlays or expenses incurred to dispose of the property. A capital gain or capital loss is calculated by subtracting the sum of the adjusted cost base and any incurred expenses and outlays from the proceeds of disposition. A positive difference is considered a capital gain, and a negative difference is considered a capital loss.
In Canada, 50% of any capital gain is taxable. This means that half of the amount of a capital gain must be added to a taxpayer’s income for the year in which the taxpayer disposed of capital property. This amount is called a taxable capital gain.
Taxpayers may use capital losses to reduce capital gains incurred in any of the past three years, and in any future year. In other words, if a taxpayer incurs a capital loss, she may apply the dollar amount of that loss against the dollar amount of any capital gain incurred in order to reduce the overall capital gain amount that she must report. The total capital gains reported in a year cannot be less than zero.
Drawing the line between dispositions of capital property and dispositions of other kinds of property often gives rise to legal ambiguity. A common ambiguity is the difference between capital property and income-generating property. Generally, when a taxpayer habitually undertakes an activity capable of producing a profit, then any profits incurred from that activity will be considered source income as opposed to capital gains. For example, if a taxpayer habitually buys and sells residential real estate property, any profits incurred from that activity may be considered business income (this is a kind of source income) rather than capital gains. It is often preferential for dispositions of property to be taxed as a capital gain rather than as source income because only half of any capital gain is taxable, whereas all source income is taxable.
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.