Strategies to Minimize Capital Gains Tax
The purpose of investing is to maximize your returns. However, the more you make when you sell investments for a profit, the greater your capital gains tax. Thankfully, capital gains receive more favourable tax treatment than ordinary income and there are legal strategies to minimize your capital gains tax even further.
What is Capital Gains Tax
Capital Gains occur when you sell an investment at a profit. That investment can be stocks, bonds, precious metals, property (excluding your principal residence), business, art, antiques, etc.
The Canada Revenue Agency only taxes 50% of your realized gains. This is to encourage investment in Canadian businesses. This means that 50% of the realized gains are added to your income and taxed at your marginal income tax rate, and the remaining 50% is tax-free.
Capital Gains Tax Minimization Strategies
“In this world nothing is certain but death and taxes” – Benjamin Franklin. While medical advancements continue to defer the former, proper planning can minimize the latter.
Use Your Lifetime Capital Gains Exemption (LCGE)
The LCGE applies to Canadian business owners and operators of farms or fisheries. The amount changes each year and is currently around $1 million. Business owners can only use the LCGE when they sell their business through a share sale.
Invest Within a Tax-Sheltered Account
Any investments you make within a Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA), or Registered Education Savings Plan (RESP) are not taxed. Therefore, you do not pay any capital gains taxes on profits realized within these types of accounts.
You do not have to pay income tax on amounts you take out of a TFSA. However, income tax is payable on distributions from RRSPs and RESPs. The advantage of long-term tax-free growth and compounding far outweigh these tax consequences.
Offsetting Capital Losses
A capital loss occurs when you sell an asset at a loss. The CRA allows you to offset capital gains with capital losses, therefore reducing the capital gains tax payable. Capital losses can be carried back to be used in the 3 preceding years and in any future year (they do not expire).
With proper planning, you can strategically sell underperforming securities near year-end, generating capital losses to offset capital gains.
Capital Gains Reserve
The CRA allows you to spread profits from capital asset sales over 5 years. By spreading capital gains over 5 years there is a greater instance that they will be taxed at a lower overall marginal rate than if you paid taxes on the total in one year.
Donate Your Shares to a Charity
By donating securities to a registered charity, taxes do not apply to the security transfer. The charity gets much more value this way than if you sold the shares, paid the tax, and donated the resulting cash. You also get a charitable tax receipt for the total value of the securities: a win-win!
Defer Capital Gains
You can defer paying capital gains tax for shares received from a parent or spouse due to death or divorce. However, when you sell the shares, the capital gain or loss is calculated from the initial purchase price that your parent or spouse paid.
Have a Plan!
Income tax planning can be complex. There can be a fine line between tax avoidance (which is illegal) and tax minimization. Careful tax planning taking into consideration your overall financial situation can minimize your capital gains tax. Working with a trusted tax professional is crucial to effective tax planning and not crossing that legal line.
Invest with Bloom Investment Counsel, Inc.
For over 25 years, Bloom Investment Counsel has been investing in dividend-paying equities for wealthy individuals, family offices, foundations, corporations, institutions, and trusts. Investing in dividend-paying stocks substantially increases the after-tax rate of return for Canadian taxable investors given that dividends are taxed at a lower rate than other income. Bloom values the partnerships that provide their expertise to our clients and is delighted to work directly with your tax advisor or other trusted professional to facilitate a coordinated approach to protecting, preserving, and building your wealth.
This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.