Some investors are questioning how to reduce the potential tax bite. Here are two planning considerations before year end.
You Asked: What is the Capital Gains Reserve?
When you dispose of capital property, you may realize a capital gain or loss: the difference between the proceeds of disposition and adjusted cost base (ACB) of the property. The capital gains reserve reduces the amount of the capital gain you report as income in a particular year by spreading it over multiple years. This may allow you to take advantage of a lower inclusion rate that applies to capital gains realized under the $250,000 threshold each year. Usually, when you sell capital property, you receive full payment at that time. Yet, by claiming the capital gains reserve, you are able to report the portion of the capital gain in the year you receive proceeds of the disposition. Generally, the maximum period over which most reserves can be claimed is 4 years, spreading out a capital gain over 5 years (for family farm/fishing property transferred to a child, a 9-year reserve period is allowed). Generally, taxpayers must claim at least 20 percent of a gain annually during each period (10 percent for farm/fishing property).
Where might this be helpful? If you’re looking to transfer a cottage or cabin within the family, this may be one way to help spread out the potential capital gains tax and take advantage of a lower inclusion rate over multiple years. However, the transaction will need to be carefully structured in order to be able to claim the reserve. To learn more, read here.
Already claiming a reserve? For business owners who have structured a sale and claimed a reserve prior to June 25, 2024, and are subject to the increased inclusion rate, consider bringing a portion of the transaction out of reserve (where possible) in 2024. This is because the CRA has stated: “The amount of a capital gain that is brought out of reserve would be deemed to be a capital gain of the taxpayer from a disposition of property on the first day of the taxpayer’s taxation year for the purpose of determining the inclusion rate.” For individuals, this is January 1, so the transaction would be subject to the 1/2 inclusion rate and not 2/3.
Don’t Just Consider Tax-Loss Harvesting: Think Crystallization!
As we approach the final months of the year, tax-loss harvesting is often used as a strategy to reduce a tax bill for non-registered accounts. This involves selling investments to trigger a capital loss to offset taxable capital gains in the same year. Tax losses can be carried back three years or carried forward indefinitely. Net capital losses of prior years continue to be deductible against taxable capital gains in the current year by adjusting their value to reflect the inclusion rate of the capital gains being offset. Thus, a capital loss realized prior to the rate change would fully offset an equivalent capital gain realized after the rate change.
However, with recent tax changes, individuals should also consider the opportunity for a lower inclusion rate for realized gains of $250,000 or less each year. Crystallization involves selling a winning position and immediately buying it back. This can potentially reduce future unrealized gains over time to lower exposure to a future higher inclusion rate. Unlike loss planning, there are no rules surrounding the repurchase of identical securities. For those in a loss position, the “superficial loss rules” mean that an investor (or an affiliated entity, e.g., spouse, RRSP, TFSA) must wait 30 days in order to buy back the same stock or the loss will be denied. Whether it makes sense to crystallize gains and “prepay” tax to take advantage of a lower inclusion rate depends on many factors including time horizon, marginal tax rates and expected rate of return, since the amount pre-paid in tax could otherwise be invested and grow over time.
If you wish to discuss these or other ways to address the increased inclusion rate, please contact our team.
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