Today we are going to talk about capital gains and how these are given a favourable tax break over other types of income. First of all a capital gain (loss) is created when you dispose of a capital property such as real estate, equipment, stocks, mutual funds,* etc. Capital gains are also realized at the time of death as the Canada Revenue Agency (CRA) deems you have disposed of all your capital assets at fair market value.

 
Capital gains that have accrued after December 31, 1971 are calculated by taking the proceeds of the disposition of the property less the adjusted cost base (ACB) and the expenses in disposing of that property.  The adjusted cost base would be the original cost of the property plus any improvements to same. If the proceeds from the sale exceed the ACB and the expenses you are deemed to have a capital gain.  Since October 2000 only 50% of the capital gain is included as taxable income. Prior to February 2000 75% of the capital gain realized was included in taxable income.
 
For example if you had mutual fund which you originally purchase for $6,500 and disposed of for $10,000, and incurred a deferred sales charge of $200 when they were sold, you would have incurred a capital gain of $3,300 ($10,000 -$6,500-$200) and would report taxable income of $1,650 (50% of $3,300).
 
If you have capital gains from the sale of certain properties you may be eligible for a capital gain exemption. This lifetime exemption limit was increased to $750,000 from $500,000 on capital gains from the disposition of certain qualified property after March 17, 2007.  Eligible capital property from which capital gains exemption qualifies include:

• qualified small business corporation shares
• qualified farm property
• after March 1, 2006 qualified fishing property; an
• a reserve after 2007 brought into income from the disposition of any of the above.

 
If you receive the proceeds from the sale of the property over several years you may be able to claim a reserve. This allows you to claim a portion of the capital gain in the year you receive the proceeds of the disposition. Generally the maximum period for a reserve is 5 years. However, a 10 year reserve period is provided for the transfer to your child of qualified farm property, qualified fishing property and small business corporation shares.
 
If you have a capital loss you can apply that to any capital gains you had in that year, to a balance of zero. If your capital losses exceed your capital gains you have net capital loss, which generally you can apply against any capital gains incurred in the three preceding years or against future capital gains. You cannot apply capital losses against any type of earned income.

 
Different types of investments are treated differently for tax consideration by CRA. Capital gains receive the most advantageous tax consideration and that should be taken into account when structuring any investment portfolio.  
 

*Mutual funds are offered through Credential Asset Management Inc. The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This article is provided as a general source of information and should not be considered personal tax advice. We are not tax advisors and we recommend that clients seek independent advice from a professional tax advisor on tax related matters. The views expressed are those of the author and not necessarily those of Credential Asset Management Inc.

September 24, 2008