What are Capital Gains?
In simple terms, capital gains are the profits you earn when selling an investment, like stocks, for a higher price than purchased.
This article breaks down Canadian capital gains taxation, offers a non-registered account stock selling example, and discusses tax-protected accounts.
Tax Implications of Capital Gains in Canada
In Canada, capital gains are subject to taxation, but only 50% of the gain is taxable. The “inclusion rate” describes this process. Your marginal tax rate applies to the taxable portion of the capital gain, adding it to your income for the year and subjecting it to taxation accordingly. The remaining 50% of the gain is tax-free.
For example, let’s say you purchased a stock for $5,000 and later sold it for $10,000, realizing a capital gain of $5,000. Only 50% of this gain, or $2,500, would be subject to tax. If your marginal tax rate is 30%, you would owe $750 ($2,500 x 30%) in taxes on this capital gain.
Selling Stocks in a Non-Registered Investment Account
A non-registered account is an investment account that does not offer any tax advantages. When you sell a stock in a non-registered account, you must report any capital gains or losses on your income tax return.
Suppose you bought 100 shares of a company’s stock at $50 per share in a non-registered account, totaling $5,000. After a few years, you decide to sell the shares at $100 each, resulting in a total sale value of $10,000. In this case, you would have a capital gain of $5,000 ($10,000 – $5,000). As mentioned earlier, only 50% of this gain would be taxable, meaning you would need to include $2,500 in your taxable income for that year.
How Can I Reduce my Capital Gains Tax Burden?
Simple – by investing in tax protected accounts! In Canada, there are tax-protected accounts such as Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) that offer various tax advantages.
Financial experts specifically design RRSPs for long-term retirement savings. Contributions made to an RRSP are tax-deductible, reducing your taxable income for the year. However, when you withdraw funds from your RRSP, the tax authorities treat the withdrawals as taxable income. Capital gains within an RRSP are tax-exempt, but withdrawals are taxed based on your marginal tax rate.
TFSAs, on the other hand, are more flexible investment accounts that allow you to save for various purposes. Contributing to a TFSA uses after-tax dollars, so you don’t receive a tax deduction for your contributions. The advantage of a TFSA is that any investment growth, including capital gains, is tax-free. Additionally, withdrawals from a TFSA are tax-free and do not affect your income-tested benefits or tax credits.
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For more on this topic, click here to access the Government of Canada’s complete 2022 breakdown of capital gains.