How Capital Gains Taxes Workand How You Can Minimize Them
Small Business Taxes, The Complete Idiots Guide to Starting a Home-Based BusinessGuide to Self-Employment, The Wall Street JournalU.S. News and World Report
Lea Uradu, J.D. is graduate of the University of Maryland School of Law, a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, Tax Writer, and Founder of L.A.W. Tax Resolution Services. Lea has worked with hundreds of federal individual and expat tax clients.
Its easy to get caught up in choosing investments and forget about the tax consequencesparticularly, the capital gains tax. After all, picking the right stock or mutual fund can be challenging enough without worrying about after-tax returns. Likewise, selling a home can be a daunting task, even before you consider the tax bill.
Still, figuring taxes into your overall strategyand timing when you buy and sellis crucial to getting the most out of your investments. Here, we look at the capital gains tax and what you can do to minimize it.
How To Reduce Or Avoid Capital Gains Tax In Canada
There are several ways to legally reduce, and in some cases avoid, paying taxes on capital gains.
The first thing to know is that capital gains can be offset with capital losses from other investments, until the balance of capital gains is reduced to zero.
If you have only capital losses in a given year, you can use them to offset gains reported to the CRA during the previous three years. You can also choose to carry those losses into the futureindefinitelyand apply them to another year. The only thing you have to remember is that you cant claim a capital loss against regular income.
You may want to keep your investments in a registered account, such as a registered retirement savings plan , a registered education savings plan or a tax-free savings account . Investments held in these accounts are tax-sheltered. With RRSPs and RESPs, youll pay tax when you withdraw the funds, and TFSA withdrawals are tax-free.
You may also choose to donate securities, such as shares and bonds, by transferring ownership to a registered charity. Taxes on capital gains do not apply to capital transfers to charitable organizations. This allows you to give more than you would with cashselling the asset first would result in taxes owedand still receive a charitable tax receipt for the amount donated.
Capital Gain Vs Capital Loss
- If you sell capital property for more than you paid for it, the resulting portion added to your net income is a capital gain.
- Conversely, if you sell capital property for less than you originally paid for it, you may have a capital loss.
Note that the actual or deemed cost of a capital property depends on the type of property and how you acquired it, and includes capital expenditures, such as the cost of additions and improvements to the property, but not current expenses.
Heres an example calculation resulting in a capital gain:
Suppose you had a rental property that you received $380,000 for when you sold it and had originally purchased for $320,000. When you bought the property, you paid legal fees of $2,600. Before you sold it, you had to have the back deck of the house replaced which cost you $4,000 and the sale of the property cost you $1,500 in legal fees.
Your calculation of capital gain or loss would then be:
Proceeds of disposition $380,000
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What Is An Ltcg Calculator
The long-term capital gains or LTCG Calculator is a utility tool, whichshows you the long-term capital gains and the LTCG tax liability, forequity-oriented mutual funds and listed equity shares.
The LTCG Calculator consists of a formula box, where you enter theholding period, the purchase value, and the sale value of theequity-oriented fund. The calculator will display the taxable short-termcapital gain or long-term capital gain, depending on the holding period.
Capital Gains Tax In Canada
You realize a capital gain when you sell a capital asset and the proceeds of disposition exceeds the adjusted cost base. Capital assets subject to this tax, according to the Canada Revenue Agency, include buildings, land, shares, bonds, andreal estate investment trustunits.
The proceeds of disposition is what you sold your capital property for, less any outlays and expenses of selling. The adjusted cost base is what you paid to acquire the capital property, including any costs related to purchasing the capital property.
The capital gains inclusion rate is 50% in Canada, which means that you have to include 50% of your capital gains as income on your tax return. The inclusion rate for personal and business income is 100%, meaning you need to pay taxes on all of your income. WOWA calculates your average capital gains tax rate by dividing your capital gains tax by your total capital gains.
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Can You Have A Capital Loss
Our definition of capital gains begs the question: Can you have a capital loss? Yes, you can. A capital loss occurs when you sell a property for less money than you originally purchased it for. In some cases, you might be able to use a capital loss to reduce your income for your tax return, if you are reporting capital gains in the same year.
Speaking of tax, a capital gains tax is the money owed in taxes from the income earned. Its not a specific tax, per se. But more on that below.
For more on the ins and outs of how capital gains works, read: Capital gains explained.
How Can You Offset Capital Gains
You’ll add together all the numbers in the gain/loss column of your worksheet when it comes time to calculate your capital gains tax liability. This allows you to offset your gains with your losses. It reduces your total taxable amount. You can offset all of your gains as well as up to $3,000 of your earned income if your losses are greater than your gains. Any losses beyond that can be rolled forward to offset gains in future years.
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Terms You Need To Know:
Full value considerationThe consideration received or to be received by the seller as a result of transfer of his capital assets. Capital gains are chargeable to tax in the year of transfer, even if no consideration has been received.
Cost of acquisition The value for which the capital asset was acquired by the seller.Cost of improvement Expenses of a capital nature incurred in making any additions or alterations to the capital asset by the seller.
- In certain cases where the capital asset becomes the property of the taxpayer otherwise than by an outright purchase by the taxpayer, the cost of acquisition and cost of improvement incurred by the previous owner would also be included.
- Improvements made before April 1, 2001, is never taken into consideration.
Capital Gains Tax Deductions And Special Circumstances
When you sell your own home, you may be subject to capital gains taxes, though things work a bit differently with real estate investments. For instance, if youre single, you can make up to $250,000 profit on your home without incurring capital gains taxes. For married couples filing jointly, this exclusion goes up to $500,000. If you exceed those marks, youll be subject to some capital gains taxes.
Collectibles are another area of capital gains that are taxed differently than standard investments. In fact, all collectibles, like art, jewelry, baseball cards and more, are taxed at a flat 28% rate.
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Sell When Your Income Is Low
Another great strategy to reduce the impact of capital gains on your investment property is to time when you sell. If you know youre heading into some thin years or your spouse is planning on quitting their job, that would be a great time to consider selling. Your income will be less, which may put you in a lower tax bracket and lower your capital gains tax responsibility.
Capital Gains Tax On Sale Of Property
Real estate property includes residential properties, vacant land, rental property, farm property, and commercial land and buildings. If you have sold real estate property, you will have to report any capital gains or losses on Schedule 3, the capital gains and losses form. If you sold both the property along with the land it sits on, you must determine how the sale price is distributed between the land and the building and report them separately on theTax Form Schedule 3.
For example, you just sold a property for proceeds of disposition less outlays and expenses of $500,000. The Municipal Property Assessment Corporation appraised the land at $125,000, meaning that the land is worth 25% of the property value. Your adjusted cost base was $400,000, so your total capital gains is $100,000, and your taxable capital gains is 50% of that, or $50,000. The taxable capital gain for the land would be $12,500 and the taxable capital gain for the building would be $37,500. However, if the government suspects the property is used for business purposes, the tax will be paid on business income rather than capital gain. This increases the inclusion rate to 100%.
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Capital Gains On Futures Contracts
Many kinds of futures contracts on equities and commodities are not traditional capital assets either. Rather, these are section 1256 contracts and are marked-to-market at the end of each calendar year. For these, a 60/40 rule applies, 60% of gains are treated as long-term and 40% as short-term regardless of how long an asset is held. Do note that different rules apply for taxpayers that are filing as a professional trader.
Most individual investors don’t trade futures. However, do note that you can end up with a section 1256 tax treatment from investing in certain exchange-traded funds. An ETF that holds commodity futures such as grains or metals may end up being taxed in this way rather than being subject to usual tax rates on capital assets.
How Tax Harvesting Helps Reduce Capital Gains Tax
In case you have invested only a small amount so far, your long-term returns from the investment will be less than Rs. 1 lakh. So, you will not have to pay any long-term capital gains tax on redemption. But, as you keep adding to your investments and your returns keep growing, your returns will exceed the Rs. 1 lakh mark and become taxable.
The below table shows how soon your returns will exceed the Rs. 1 lakh mark in case of different lump-sum investment amounts assuming annual returns of 12% p.a. on your investments:
|Growth of Returns for Different Lump Sum Investment Amounts|
|Capital Gains Tax Payable||Rs. 6,000|
As you can see, by using tax harvesting, you avoided paying Capital Gains Tax on your Mutual Fund investments.
Tax Harvesting will also work when you take the SIP route to invest. All you have to do is redeem units that qualify for long-term capital gains i.e. have been held for 12 months or more and reinvest the proceeds every time.
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How Does Finitys Capital Gains Calculator Work
The functionality of Finitys capital gains calculator can be easily understood with the help of an example.
Scenario 1: long-term capital gains Suppose you bought or invested in 100 stocks of Infosys Ltd at Rs. 1,000 per share in June 2018 and sold them at Rs. 1,500 per share in February 2020.
Scenario 2: long-term capital gains However, if you had bought 500 shares on the same date and at the same price, the LTCG would be = 2,50,000
Thus, the tax will be applied on: at 10%. LTCG tax will therefore be Rs. 15,000. .
Scenario 3: short-term capital gains Suppose you had bought 100 stocks of Infosys Ltd at Rs. 1,000 per share in June 2020 and sold them at Rs. 1,500 per share in December 2020.
Thus, the holding period of the stocks is less than one year. The short-term capital gains will be applied on Rs. 50,000 , which is the profit made from the sale. Since these returns are generated from equities and the same falls under Section 111A of the Income-tax Act, the applicable tax rate will be 15%.
Thus, short-term capital gains tax will be = 50,000*15% = 7,500. The net proceeds have to be adjusted for brokerage or other purchase-related expenses.
Managing The Tax Impact
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Capital Gains On The Sale Of A Property
There are many misconceptions about capital gains tax in Canada, including the belief that all gains are taxed at a rate of 50%. In reality, only half of a realized capital gain50% of the income you earn from selling an assetis taxed at your marginal tax rate.
This means the amount you end up paying in tax will depend on the degree to which your asset has grown in value, as well as your other sources of income. And between tax-sheltered investment accounts, the principal residence exemption and the rules around capital losses, there are many legitimate ways to ensure you dont pay more tax than necessary in any given year.
Cra Capital Gains Exemptions
The main CRA capital gains exemption applies in situations where you are selling your primary residence. While recent changes mean that you have to list the details of any property you sell on your taxes, you do not have to pay capital gains when you sell your principal residence.
However, the principal residence CRA capital gains exemption can sometimes get complicated.
A principal residence does not have to be where you live all the time. If you, your spouse, or your children live in a property at some point during the year, you can consider that property to be your principal residence. However, you can only designate one property per year as a primary residence. There is no minimum period for how long you or a family member must live in the home for it to qualify. However, the CRA will look at evidence to determine if a property was truly your primary residence.
This means the agency will look at several factors, including how long you owned the property, how often you buy and sell property, and your profession to determine if you actually lived in the property or if you flipped the home. For instance, if you are a contractor or builder by trade, the CRA is more likely to assume you purchased the property with the intent of flipping it for profit.
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What Is An Asset
Under the Income Tax Act, 1961 a capital asset is any asset irrespective of being held for business or personal use. It may be movable, immovable, tangible or intangible, fixed or circulating. These assets include land and house property, shares and stocks, bonds and debentures, mutual funds, and trademarks.
About Long Term Capital Gains Tax
Long-term capital gains tax in India is to be looked at as pre-2018 budget and post-2018 budget. That is because the Union Budget 2018 declared long-term capital gains tax applicability on equity mutual funds, which were not taxable for investors until then. As per this announcement, a flat 10% long-term capital gains tax applies to all equity and equitymutual fund investments.
Definition of LTCG
LTCG or long-term capital gains tax is payable on profits generated from such capital assets that are held for a long term. The total period of holding, either short term or long term, can differ across asset categories. Mentioned below are the periods for which the respective assets returns are considered as long-term:
Long-term capital gains tax is applicable at 10% on capital gains over Rs. 1 lakh that are generated from stocks or equity-oriented mutual funds held for over one year.
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