What are Capital Gains?
In simple terms, capital gains are the profits you earn when you sell an investment, such as stocks, for a higher price than you paid for it.
In this article, we’ll break down Canadian capital gains taxation, provide an example of selling stock in a non-registered account, and discuss 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. This is known as the “inclusion rate.” The taxable portion of the capital gain is added to your income for the year, which is then taxed at your marginal tax rate. 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.
Imagine you purchased 100 shares of a company’s stock at $50 per share in a non-registered account, for a total cost of $5,000. A few years later, you decide to sell the shares for $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.
RRSPs are designed 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 withdrawals are treated as taxable income. Capital gains realized within an RRSP are not subject to capital gains tax, but the withdrawals are taxed at your marginal tax rate.
TFSAs, on the other hand, are more flexible investment accounts that allow you to save for various purposes. Contributions to a TFSA are made with after-tax dollars, meaning 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 anyone interested in reading more on this topic, click here to the Government of Canada’s full breakdown of capital gains for 2022.