All About Capital Gains Tax For Real Estate In Canada
When you own real estate that is not your principal residence, you’ll likely run into capital gains tax somewhere down the road. We sat down with Gary Li, CPA, CA, to clarify the key capital gains tax implications for real estate properties in Canada. Let’s get started!
When Is Real Estate Capital Gains Tax Triggered?
- Selling A Property: Selling a property that is not your principal residence for more than what you paid might mean owing capital gains tax.
- Changing A Property’s Use: If you decide to convert your rental property into your principal residence, it could trigger a capital gains tax, even if you don’t sell it. This happens if the rental property’s appraised value at the time of the switch is higher than when you started renting it out.
Exceptions to Capital Gains Tax
- Principal Residence: You don’t pay tax on capital gains if the property was your main home.
- Majority Residence: If you live in the majority of the home, you might avoid capital gains tax if you meet a few conditions. These include not making significant changes to the property to enhance its rental or business potential, not deducting CCA, and that the rental or business use of the property is small compared to its use as your principal residence. For the most up to date information, please consult your accountant or refer to the CRA website.
- 4-Year Rule: You can consider a property your principal residence for up to 4 years, as long as you’re not claiming another principal residence during that time and you are not claiming CCA on the property. For the most up to date information, please consult your accountant or refer to the CRA website.
Capital Cost Allowance (CCA): This is an annual tax break you can claim for certain assets that lose value over time.
But here’s the deal: if your capital gains are more than what you’ve deducted in CCA, the CCA will be “recaptured”, which means you’ll need to pay income tax on the CCA previously deducted.
How Do You Calculate Capital Gains Tax?
Capital gains tax is calculated on the capital gains between what you sell the property for (in the case of a sale) or it’s appraised value (in the case of a change in use) and what it was initially valued at, plus any major upgrades you’ve made.
Starting June 25, 2024, the CRA is shaking things up on how they calculate capital gains tax.
- Owning In Your Personal Name: If your capital gains are $250,000 or less, half of those gains will be added to your personal income over $250,000 and taxed. But if your gains exceed $250,000, two-thirds of the gains will be added to your personal income over $250,000 and taxed.
- Owning In A Corporation: Two-thirds of all capital gains will be added to your corporate income over $250,000 and taxed.
Curious about how this tweak could affect you as a real estate investor in Canada? Dive into this video for more details!
When Must Capital Gains Tax Be Paid?
Selling A Property: You owe capital gains tax when you file your taxes for that year.
Changing A Property’s Use: If you haven’t physically sold the property but it’s considered sold for tax purposes (“deemed sale”), you have a couple of options. You can either pay the tax when you file taxes for that year, but that might be tough since you haven’t actually received proceeds from the sale. So, the CRA allows you to delay paying the tax until you actually sell the property – this is called a “deferred election”. Just keep in mind that if you choose this option, you can’t claim CCA on the property. For the most up to date information, please consult your accountant or refer to the CRA website.
What's Happening in Toronto's Real Estate Market?
Should I Defer Capital Gains On A Deemed Sale?
If your property has a deemed sale, you’ll need to weigh the options of deferring capital gains taxes (a “deferral election”) or claiming CCA against your rental income:
- In Toronto, where property prices shoot up more quickly, deferring taxes and possibly claiming the principal residence exemption for an extra four years can be a big advantage.
- But if your property’s appreciation is slower, and you’re planning to hold onto it for a while, claiming CCA might make more sense.
Let’s look at an example.
You bought a rental property for $600,000 in Year 1, turned it into your principal residence in Year 5 when it was worth $850,000, and then sold it for $1,100,000 in Year 10.
We’ll assume you’ve been claiming the maximum CCA each year and that the building’s value at the start was $300,000, half of the property’s purchase price.
Let’s simplify things and assume a basic 50% marginal tax rate for our rough calculations.
Option 1: Deferral election is not taken, but can claim CCA
- Without deferring the taxes, the $250,000 increase in value from Year 1 to Year 5 gets taxed in Year 5, even though you didn’t actually sell the property.
- 50% of capital gains are taxed at your marginal tax rate, which means your capital gains tax is $62,500 in Year 5.
- Although you claimed CCA deductions totalling $50,292 for the first 5 years, you will have to recapture this in Year 5. The tax impact here is $25,146 in year 5.
- After this, no capital gains taxes apply since it is now your principal residence.
Option 2: Deferral election is taken, but cannot claim CCA
- If you choose to defer the taxes, you won’t have to pay capital gains tax until you sell the property in Year 10.
- If you did not own another home, you can consider it your principal residence for up to 4 years leading up to the switch.
- So, the final capital gains tax impact here in Year 10 is $12,500 ($250,000 / 5 for the one year taxable x 50% capital gains considered x 50% marginal tax rate).
Here’s a table comparing the tax impacts of the two options.
- Even if we don’t consider the time value of money, it’s clear that option 2 (Deferral election) is the more tax-efficient pick.
How We Can Help
Real estate investors have a lot to think about – including things like tax implications. When you partner with our real estate sales brokerage, we can plug you into the right network to aid in making informed decisions.
We’re not your run-of-the-mill real estate sales brokerage. Our focus is on leveraging data to enhance real estate investing decisions in Toronto.
This involves seeking out robust investments with positive cash flow, strategizing for risk management, and identifying opportunities to increase returns through value-add renovations and in burgeoning areas.
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