Dale Jackson

Personal Finance Columnist, Payback Time

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99.87 per cent of Canadian investors dodged a tax bullet in this week’s federal budget. 

Ottawa’s plan to raise the inclusion rate to two-thirds from one-half for capital gains over $250,000 annually will only impact 0.13 per cent of taxpayers with average incomes of $1.42 million, according to the federal government.

Capital gains are accrued when an investor sells an asset such as a stock, property or business. The inclusion rate is the portion that is taxed at the filer’s marginal rate. 

Concern over a hike in the capital gains tax has persisted since the minority Liberal government came to power, but there are options for most retirement investors to avoid it at any rate. 

Investing strategically through registered accounts

The most tax-efficient way to invest is through a tax-free savings account (TFSA), where capital gains - or any income – are never taxed. 

The total TFSA contribution limit was expanded by $7,000 on January 1. That means an additional $7,000 in contribution space for the vast majority of Canadians who have not contributed the maximum allowable amount in previous years. Allowable amounts are carried forward each year.

Total contribution space varies for individuals based on contributions and withdrawals made over the years. To get an idea of how significant the TFSA has become, the total allowable amount since it was introduced in 2009 is now $95,000.

The combined power of a TFSA and RRSP

Originally billed as a short-term savings vehicle for things like vacations or home renovations, the TFSA has grown into a potential retirement tax-planning tool that can complement a registered retirement savings plan (RRSP). 

Their differences are their strengths. RRSP contributions can be deducted from taxable income (unlike TFSAs) and grow tax-free, but those contributions and the returns they generate over time are fully taxed at the individual’s marginal rate when they are withdrawn.

With proper planning, RRSP withdrawals can be capped at the lowest marginal tax rate in retirement and topped up with tax-free money from a TFSA - lowering the overall tax bill significantly.

Both RRSPs and TFSAs can hold just about any type of investment including stocks traded on major exchanges, bonds, mutual funds or exchange-traded funds (ETFs).

It’s important to note that investments in a non-registered account can not be transferred to a registered account. Investors must sell the investment first and pay the applicable capital gains tax.

On the bright side, capital losses from the sale of equities in a non-registered account can be used to offset capital gains going back three years or forward at any point in the future.   

Investing in second properties is a worse idea

Capital gains on the sale of a principal residence are not taxed, which makes owning a home a tax-efficient investment as well.

A capital gains tax, however, is applied to the sale of any additional properties such as cottages or rental properties. If the capital gain exceeds $250,000 the inclusion rate will now be two-thirds.

An example of how the new rules might apply provided by the Department of Finance this week said that a high-income earner in Ontario with a $400,000 salary and a capital gain of $300,000 from selling a second property would pay 50 per cent of that gain, plus an additional two-thirds.

As a result, their tax payment would rise to $158,333. Under the current rules, they would have only paid $150,000.

The higher capital gains inclusion rate is the latest in a series of federal government clampdowns on tax perks for second properties.

Alternatively, investors looking to get diversified real estate exposure beyond their principal residence without tax implications have the option of buying real estate investment trusts (REITs) in their TFSA.