What Real Estate Investors Need to Know
The Canadian government recently announced changes to the capital gains inclusion rate, a significant shift that was first introduced in the 2024 budget. Now that the motions have been tabled to pass this change into legislation, it’s crucial for real estate investors to understand the implications of this update.
Understanding the New Capital Gains Inclusion Rate
As part of the 2024 federal budget, the Canadian government has proposed an increase in the capital gains inclusion rate. Historically, 50% of your capital gains were taxable. Under the new legislation, the inclusion rate will increase to 66.67% for all transactions after June 25, 2024.
To put it simply, if you make a capital gain of $100,000:
- Old Rule: $50,000 is taxable.
- New Rule: $66,667 is taxable.
This change impacts not only the sale of real estate but also other capital assets such as shares, paintings, and even collectibles. It’s crucial to understand how this new rate will affect your investments and overall tax planning.
Capital Loss Treatment
With the increase in the inclusion rate, the treatment of capital losses also changes. Here’s how it works:
Suppose you incurred a $300,000 capital loss before June 25, 2024. Capital loss can be used to offset against future capital gains to reduce the amount of taxes you owe.
Since the gain is incurred prior to June 25, 2024 with 50% inclusion rate, the net capital loss is $150,000 ($300,000 x 50%).
Now in 2025, you are realizing a capital gain of $400,000 in your personal name.
How would you apply this $150K net capital loss carried forward from prior year to offset against this $400,000 capital gain?
Our government gave us a really complicated example in this link. But the easiest way to understanding and calculate the amount would be to use the gross capital gain, the amount before applying the inclusion rate.
In this case, capital gain incurred is $400K before inclusion rate calculation (in this case, the inclusion rate would have been ½ for the first $250K, and 2/3 for the remaining $150K – as you can see, it gets quite complicated).
Similarly, capital loss realized is $300K before applying the inclusion rate calculation.
Capital gain after capital loss carried forward = $400,000 – $300,000 = $100,000
Under the new rule, the first $250K capital gain realized is subject to 50% inclusion rate. Since capital gain after capital loss carried forward is $100,000, 50% inclusion rate is applied.
As a result, taxable capital gain = $50,000.
In a nutshell, your capital losses carried forward will be adjusted to offset against the capital gain realized after the rule change, based on the corresponding inclusion rate. You’re not in any disadvantaged position as a result of the change in inclusion rate.
Vendor Take Back Mortgage with Capital Gain Reserve
If you’re using a vendor take back mortgage, it’s crucial to understand how the new inclusion rate affects the capital gain reserve. When selling property and receiving payments over several years, you can defer some capital gains.
For the taxpayers who have vendor take back mortgage and have been deferring a portion of the gain to future years, you might want to consider realizing all the gains before June 25, 2024.
Capital gain inclusion rate will be based on the time of recognition, not based on when the sale occurred.
A corporation may have sold a property with a vendor take back mortgage before June 25, 2024. The corporation is eligible to defer a portion of the capital gain to next five years. However, since the capital gain inclusion rate is calculated based on the time the capital gain is realized, it would be more advantageous to the taxpayer to opt out of spreading out the capital gain. Instead, the corporation should recognize the capital gain before June 25.
On the flip side, if you are an individual, you have an option for vendor take back mortgage. You’re able to enjoy the multi-year annual $250,000 preferential 50% inclusion rate treatment.
As always, if you are entering into a vendor take back mortgage scenario, make sure you consult with your accountant to ensure you pay the minimum amount of taxes possible.
What’s Not Changing from the budget announcement ☹
- Principal Residence Exemption: The government is maintaining the principal residence exemption, ensuring that capital gains from selling your home remain tax-free.
- Tax Elections:
- Current rules do not allow taxpayers to elect to realize a gain or loss without an actual transfer. This remains unchanged.
- What this means is that you have to do an actual sale of an asset, either to your spouse or to another party, to trigger the capital gain. You cannot simply file an election to realize the capital gain without transfer of ownership.
- What this also means is that you are required to trigger land transfer tax on the sale and incur additional legal fees just to realize the capital gain at 50% inclusion rate. ☹
- Capital Gains Averaging:
- Say you have a property that has accrued gain of $400,000, and you know that the first $250K of the gain has the preferential 50% inclusion rate, you might want to realize $250K of the gain in year 1, and then realize the remaining $150K in year 2, so the entire $400,000 gain can enjoy the preferential 50% inclusion rate since gains recognized in both years are less than $250K.
- The legislation specifically states that this type of averaged over multiple years is NOT allowed.
- Splitting the Threshold: Individuals cannot share their $250,000 annual threshold with corporations they own. This benefit is strictly for individual taxpayers.
- If you think you can somehow share your $250,000 annual threshold with a corporation that you own, sorry, the current draft legislation is saying that the benefit is strictly available for individual taxpayers only.
- Exemptions or lack there of:
- Corporations and family trusts are still excluded from the $250K 50% inclusion rate calculation. In another words, if you own properties in a corporation and realize capital gains, unlike individuals, the corporation is not entitled to the 50% inclusion rate for the first $250K gain.
- The government seems to prefer to penalize people who choose to own properties inside their corporation for financing and legal liability protection with this new rule. They failed the tax integration regime that our Income Tax Act follows.
- Time-Based Distinctions: The same inclusion rate will apply for all capital gains, regardless of the type of asset or the length of time it was held before selling.
- Say you have accrued gain of $400,000 on a property as of June 2025.
- When you eventually sell the property 2 years in 2027, you gain an additional $100K, so you will make a total of $500K on the sale of this property.
- Some taxpayers, particularly the older ones that have experienced the time-based distinctions in the past, asked if the $400K gain as of June 2025 could be subjected to 50% inclusion rate and the remaining $100K is then subjected to 2/3 inclusion rate.
- After all, the additional $100K is incurred during the period after the new rule comes into effect.
- The legislation essentially said NO!
- The entire $500,000 will be subjected to the new rule. If the taxpayer is an individual and has no other capital gain or loss reported, the first $250,000 is subject to 50% inclusion rate. The remaining $250,000 is subject to 2/3 inclusion rate.
Conclusion
Hopefully, this draft legislation can shed some light on how you structure your future portfolio. For those of you who wants to take advantage of the lower capital gain inclusion rate before June 25, the draft legislation also provides clarify on some issues.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
