With the recent adjustments to capital gains tax in Canada, it’s important for investors to stay informed about the latest changes, particularly as we move into 2025. Below, we’ll walk through the key aspects of capital gains tax, highlighting some of the most important updates and providing strategies for managing your tax liabilities.

Key Takeaways:

• Capital gains tax in Canada is applied when you sell an asset or investment for more than you originally paid for it.
• The most significant change in capital gains tax involves an increase in the inclusion rate from 50% to 66.7% for certain individuals and corporations.
• To reduce or eliminate capital gains tax, investors can use strategies such as the principal residence exemption, the lifetime capital gains exemption, and tax-advantaged accounts like TFSAs and RRSPs.

What Are Capital Gains?

Capital gains occur when you sell a financial asset, such as stocks, bonds, or real estate, for more than the cost of acquiring it. The profit from this transaction is known as a capital gain. Capital properties that can incur capital gains include securities (like stocks and bonds), real estate, and other assets such as antiques or collectibles.

When you sell an asset for more than its adjusted cost base (ACB), which is the original purchase price plus any expenses related to acquiring it (such as legal fees or commissions), the difference is your capital gain. For instance, if you bought a stock for $1,000 and sold it for $2,500, your capital gain would be $1,500.

How Are Capital Gains Taxed in Canada?

In Canada, only 50% of capital gains are subject to tax. This is called the inclusion rate. The reason for this preferential treatment is to encourage investment by offering a lower tax rate on capital gains compared to regular income, which is fully taxable.

For example, if you earned a capital gain of $1,500, only half of that amount ($750) would be taxed at your marginal tax rate.

What’s Changing in Capital Gains Tax for 2025?

Several changes to capital gains tax were introduced in the 2024 federal budget, which will affect how capital gains are taxed in the coming years:

1. Increased Inclusion Rate for High Capital Gains
   Starting in 2025, the inclusion rate for individuals and corporations will rise from 50% to 66.7% for capital gains above $250,000. For capital gains under this threshold, the 50% inclusion rate remains in effect. Corporations and trusts will face the new 66.7% rate for all capital gains, with no lower rate for smaller amounts. This change mainly impacts those with substantial capital gains income, and it’s recommended to seek professional advice on how to manage this tax increase.
2. Lifetime Capital Gains Exemption (LCGE) Increase
   The LCGE, which applies to the sale of small business shares or certain farm and fishing properties, will rise from $1 million to $1.25 million, with adjustments for inflation starting in 2026. This increase provides more room for tax-free capital gains on eligible assets.
3. New Canada Entrepreneurs’ Incentive (CEI)
   A new incentive for Canadian entrepreneurs will be introduced in 2025, reducing the capital gains inclusion rate to 33% on up to $2 million in eligible gains. This will be phased in gradually, increasing by $200,000 annually over ten years.

How to Calculate Capital Gains Tax in Canada

To calculate your capital gains tax, you’ll need to know three key factors: the proceeds of disposition (the amount received from selling the asset), the adjusted cost base (ACB) of the asset, and any expenses incurred to sell the asset. The formula to calculate your capital gain is:

Capital Gain/Loss = Proceeds of Disposition – (ACB + Outlays and Expenses)

Proceeds of Disposition: This is the total amount you receive from selling the asset, including compensation for destroyed or stolen property.

Adjusted Cost Base (ACB): This is the original cost of the asset, plus any capital improvements, such as renovations. It does not include routine maintenance or repairs.

Outlays and Expenses: These include legal fees, commissions, and other costs related to the sale of the asset.

Capital Gains vs. Other Investment Income

Capital gains are different from other types of investment income, such as interest or dividends. Here’s how they compare:

• Capital Gains: Only 50% of the capital gain is taxable, and it is added to your taxable income, taxed at your marginal rate.
• Interest Income: Interest income from bank accounts, bonds, and GICs is fully taxable at your marginal tax rate.
• Dividend Income: Dividends are also taxable, but Canadian dividends may benefit from a dividend tax credit, which reduces the effective tax rate.

If these incomes are held in registered accounts like a TFSA or RRSP, they can grow tax-free or tax-deferred, depending on the type of account.

What Are Capital Gains and Capital Losses?

Capital gains occur when you sell an asset for more than its ACB, while capital losses happen when you sell an asset for less than its ACB. If you incur a capital loss, you can use it to offset any capital gains in the current year, or carry it back to previous years or forward to future years, reducing your taxable income.

Exemptions from Capital Gains Tax

There are several exemptions that can reduce or eliminate capital gains tax:

• Principal Residence Exemption: When you sell your primary home, the capital gain from the sale is exempt from tax, provided the home was your principal residence for each year you owned it.
• Lifetime Capital Gains Exemption (LCGE): As mentioned earlier, the LCGE allows for tax-free gains on certain small business shares and farm or fishing properties. The exemption limit is currently set at $1.25 million and will be indexed to inflation.
• Gifted Property: If you transfer capital property to your spouse or common-law partner, there is no immediate capital gain or loss. However, the recipient will face capital gains tax if they sell the property in the future.
• Charitable Donations: Donating certain types of capital property to registered charities may eliminate the capital gains tax, provided certain conditions are met.

Strategies to Reduce Capital Gains Tax

1. Tax-Sheltered Accounts: Using accounts like TFSAs and RRSPs allows capital gains, dividends, and interest to grow tax-free or tax-deferred.
2. Tax-Loss Harvesting: You can offset your capital gains by selling investments that have incurred losses. These losses can be used to reduce your taxable capital gains, minimizing your overall tax liability.
3. Mortgage Investment Corporations (MICs): MICs are an attractive investment option for those looking to earn income unrelated to the stock market. MICs can be held in registered accounts like TFSAs and RRSPs, and when used in these accounts, all investment growth remains tax-free or tax-deferred.

Conclusion

Navigating capital gains tax in Canada can be complex, especially with the recent changes to inclusion rates and exemptions. By understanding how capital gains are taxed and implementing strategies to manage your tax liabilities, you can make the most of your investments. Whether using tax-sheltered accounts, taking advantage of exemptions, or utilizing tax-loss harvesting, there are several ways to reduce the impact of capital gains tax on your portfolio.