An increase in Canada’s capital gains tax inclusion rate came into effect on June 25. As the political fog clears, life pretty much continues the way it always has an estimated 99.9 per cent of Canadians, according to the federal government. However, this number has been disputed by industry groups, medical professionals and farmers.
The rest, including corporate executives with share plans, wealthy business owners, real estate speculators and anyone with an average income over $1.4 million, must now pay tax on two-thirds of any gains over $250,000 in a year instead of half.
Capital gains are accrued when an individual 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.
For the average retirement investor with a good tax strategy, there are tools available to avoid paying a capital gains tax at any rate.
Investments can grow tax-free in a TFSA
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 Jan. 1. That means there is 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.
Assuming Ottawa continues to expand the TFSA contribution limit, long-term investors will have a significant tax shelter to grow their savings.
Balance your TFSA with RRSP investments
Originally billed as a short-term savings vehicle for things like vacations or home renovations, the TFSA has grown into a 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contributions and the returns they generate over time are fully taxed at the individual’s marginal rate when they are withdrawn.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.
The case for investing in second properties is weaker
Capital gains on the sale of a principal residence are not taxed, which makes owning a home as tax-efficient as a TFSA.
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 is now two-thirds.
An example of how the new rules might apply provided by the Department of Finance says 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.
If you are fortunate enough to exceed your allowable RRSP and TFSA limits you can still avoid paying capital gains tax by donating the spillover capital gains to a registered charity.