The two biggest strategies to reduce Canadian income taxes on capital gains

Buying a property or business in Canada? When you sell, you might be hit with a tax bill.

Many newcomers will be residents of Canada for tax purposes. They will have a Social Insurance Number (SIN) and will have to file income taxes with the Canada Revenue Agency (CRA) annually.

Read on to learn about the major capital gains tax exemptions which newcomers can legally use to reduce their tax bill.

Note: Canadian tax legislation is complex. This article simplifies some concepts. Nothing in this article should be construed as financial advice or tax advice. Newcomers should always consult reputable and experienced tax professionals prior to making a decision on any of these strategies.

Principal residence exemption

Generally, when you sell or otherwise dispose of a capital asset, including a home, you are subject to capital gains taxes. This means that you have to pay income tax at your marginal tax rate on the amount of the capital gain which is taxable.

The capital gain is equal to the amount of the disposition (e.g., the amount you sell the asset for, or its fair market value), minus the asset’s adjusted cost base (ACB) (the amount you paid for it, minus depreciation, plus capital expenditures).

For example, if you buy a rental property for $50,000, and sell it for $250,000, you’d have a capital gain of $200,000 for your income tax return on the year in which you sold the rental property. At the current capital gains inclusion rate of 50% (for individuals, for gains of less than $250,000), you’d owe income taxes on $100,000. If your marginal tax rate is 50%, you’d owe $50,000 in taxes.

Canadian tax legislation provides an exemption to capital gains for the sale or disposal of a tax payer’s principal residence. This means that if you’ve lived in your principal residence for the entire time that you’ve owned it, and if you qualify for the exemption, you will normally not need to pay any income taxes when you sell or otherwise dispose of your home. Any gains you get from the disposition of your principal residence will generally be tax-free, provided it's been your principal residence for the entire time you've owned it.

A property must qualify in order to be a principal residence. You will have to identify your principal residence annually on each tax return you file.

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Lifetime capital gains exemption

Canadian tax legislation provides for a “lifetime capital gains exemption” for gains realized on the sale or disposition of qualified property. Qualified property includes the following:

Qualified small business corporation shares (QSBCS);
Qualified farm or fishing property (QFFP); and
Reserves and trusts of the above.

Each individual tax payer may take advantage of this lifetime capital gains exemption, provided they qualify.

For 2023, the lifetime capital gains exemption is $971,190. An individual taking advantage of the full exemption would thus reduce their taxable income by $485,595 (one half of the capital gains exemption). Assuming this individual is in the 50% marginal tax bracket, this would save them over $200,000 in income taxes, assuming they are in the 50% marginal tax bracket.

Non-Residents are not eligible

To claim the lifetime capital gains deduction, you must be a resident of Canada for tax purposes when you dispose of the property.

How do I know if I’m a resident of Canada for tax purposes?

The CRA considers several factors in determining tax residency, including the following:

How much time you spend in Canada;
Whether you have a home in Canada;
Whether you have a spouse, common law partner, and/or dependents in Canada;
Personal property in Canada;
Economic ties to Canada;
Health insurance in Canada;
Canadian government identification.

This is not an exhaustive list.

Even if you have left Canada, you may be considered a factual resident of Canada under certain circumstances if you maintain residential ties.

Individuals can consult Income Tax Folio: S5-F1-C1: Determining an Individual’s Residence Status.

They can also call the CRA at 1-800-959-8281 (from anywhere in Canada and the United States) or 613-940-8495 (from outside Canada and the United States).

Beware of tax scams

Be especially wary of anyone approaching you with offers to help you avoid paying income taxes. Tax reduction strategies are legal; they take advantage of legislation. Tax avoidance or tax evasion is illegal, and such scams are unfortunately very common. Always consult with a reputable and experienced tax professional prior to making any decisions.

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