Announced in Budget 2024, the capital gains inclusion rate is set to increase from one-half to two-thirds for corporations and trusts as well as individuals on the portion of gains exceeding $250,000. The Department of Finance Canada recently announced that it will proceed with these measures, impacting capital gains realized on or after June 25, 2024.
Crowe MacKay's trusted tax advisors summarize how the new rules will impact you or your business. If you require assistance, connect with us in Alberta, British Columbia, the Northwest Territories, or the Yukon.
Basic Inclusion Rate and $250,000 Threshold for Individuals
As of June 25, 2024, the basic inclusion rate for capital gains and losses will increase from one-half to two-thirds. This change is significant for those who need to plan their finances accordingly. However, there are nuances to consider:
- Individual Exemption: Individuals (excluding most trusts) can be subject to the one-half inclusion rate for capital gains under the $250,000 threshold in a given year. This means the new two-thirds inclusion rate will only apply to gains exceeding this threshold.
The inclusion rate reduction would be available on capital gains realized directly by individuals, including such amounts from capital gains reserves, partnerships and trusts.
For properties jointly owned by multiple individuals, each person's $250,000 threshold will apply separately, potentially reducing the overall tax burden.
Graduated rate estates and qualified disability trusts would also be eligible for the $250,000 threshold available to individuals regarding capital gains not allocated to a beneficiary in the year.
- Consistency in Deductions: Deductions such as the Lifetime Capital Gains Exemption (LCGE) and others are adjusted based on the inclusion rate applied to capital gains. This ensures that the deductions are consistently applied, whether the gains are taxed at the one-half or two-thirds rate.
Net Capital Losses
Net capital losses can be strategically utilized to reduce taxable capital gains by carrying them back or forward to offset gains in other years. The value of these losses would be adjusted to match the inclusion rates of the gains they offset.
- Carryover Periods: Net capital losses may be carried back three years and forward indefinitely to reduce capital gains in other tax years.
- Adjustment for Inclusion Rates: Losses must be adjusted to reflect the inclusion rate of the capital gains they are set to offset. This ensures that a loss from a year with a different inclusion rate still effectively offsets a gain in another year.
| Inclusion Rate at Time of Capital Loss | Inclusion Rate of Offsetting Capital Gain in Tax Return Year | |
|---|---|---|
| One-Half Two-Thirds | ||
| One-Half | 1 | 4/3 |
| Two-Thirds | 3/4 | 1 |
| Three-Quarters | 2/3 | 8/9 |
Example
Assume the following applies to an individual in the 2025 tax year.
- Realizes a capital gain of $450,000.
- Realizes a capital loss of $50,000.
- Has a net capital loss of $150,000 from 2017 (capital loss of $300,000).
Net Capital Gain Calculation
The individual's net capital gain for 2025 is $400,000.The first $250,000 is subject to a one-half inclusion rate, resulting in a taxable capital gain of $125,000. The remaining $150,000 is taxed at a two-thirds inclusion rate for a taxable gain of $100,000. Together, these amounts result in a total taxable capital gain of $225,000.
Application of Prior-Year Net Capital Loss
The individual deducts a total of $175,000 of their prior-year net capital loss against the taxable capital gain. This includes $100,000 offsetting the gains taxed at the two-thirds rate and $75,000 against the gains taxed at the one-half rate. This strategic use of net capital losses reduces the taxable gains, effectively leaving a reduced taxable capital gain of $50,000.
Resulting Taxable Capital Gain
After applying the deductions, only $50,000 of the taxable capital gain remains, which is effectively taxed at the lower one-half rate.
This example illustrates how net capital losses are applied first to offset capital gains subject to the higher inclusion rate.
Transition Year
Starting June 25, 2024, new rules will apply for the treatment of capital gains and losses due to changes in the basic inclusion rates. These changes require taxpayers to apply different inclusion rates for gains and losses realized before and after this date.
- Capital Gain and Loss Periods: Taxpayers must distinguish between capital gains and losses realized before June 25, 2024, (Period 1) and on or after this date (Period 2).
- Netting Process: Gains and losses within the same period are netted against each other to determine a net gain or loss for that period.
- Inclusion Rates:
- For Period 1: Gains and losses are subject to the one-half inclusion rate applicable before June 25, 2024.
- For Period 2: The higher inclusion rate would apply, except for the portion up to the $250,000 threshold for individuals, which may be offset by any net loss from Period 1.
Example
Robert realizes a capital gain of $600,000 on June 1, 2024, a capital loss of $75,000 on July 25, 2024, and a capital gain of $475,000 on October 1, 2024.
Period 1:
- Robert's capital gain of $600,000 on June 1, 2024, is taxed at the one-half inclusion rate, resulting in a taxable gain of $300,000.
Period 2:
- Robert's transactions result in a net gain of $400,000.
- The one-half inclusion rate applies to the first $250,000, and the two-thirds rate applies to the remaining $150,000, leading to a taxable gain of $225,000 for Period 2.
- Robert's total taxable gain for 2024 amounts to $525,000.
Capital Gains Reserves
Taxpayers may defer recognizing capital gains on certain transactions, with the actual timing of recognition depending on when payment is received. This deferral mechanism is often referred to as a capital gains reserve.
- Family Transfers: For sales of farm or fishing property or small business shares to a descendant (child, grandchild, great-grandchild), a minimum of 10% of the gain must be recognized annually, allowing up to a ten-year deferral. Bill C-59 proposes extending this ten-year period to intergenerational business transfers and sales to employee ownership trusts.
- Other Capital Property: For other types of capital property, at least 20% of the gain must be included in income each year, permitting a maximum five-year deferral period.
Inclusion Rate Considerations
When a capital gain is brought out of reserve in a subsequent year, it is included in the taxpayer's income at the inclusion rate applicable for that year. For example, if a reserve is claimed on a gain realized in 2023, any portion of the gain that is brought into income in 2025 would be taxed at the two-thirds inclusion rate unless specific conditions apply (e.g., falling under the $250,000 threshold for individuals, which could reduce the rate to one-half).
Impact of Legislative Changes on Taxation Years Straddling June 25, 2024
For taxation years before and after June 25, 2024, gains brought out of reserve are treated as arising on the first day of the taxpayer's taxation year.
Example
On April 1, 2024, Mio closed a deal to sell a property to an arm's length corporation for $20 million. Under the terms of the deal, the buyer will pay $4 million on April 1, 2024, and will make four additional payments of $4 million on April 1, 2025, through 2028. The capital gain arising on the sale is $10 million.
Immediate Full Inclusion
If Mio opts to recognize the entire $10 million capital gain in
2024, it would be taxed at the one-half inclusion rate, leading to
$5 million in taxable capital gains for that year.
Five-Year Capital Gains Reserve
- 2024: By including only 20% of the capital gain ($2 million) under the reserve rules, the taxable capital gain for 2024 would be $1 million at the one-half inclusion rate.
- 2025 to 2028: Assuming Mio has no other gains for these years, the first $250,000 of the annual $2 million gain would continue to be taxed at the one-half inclusion rate. The remaining $1.75 million each year would be taxed at the two-thirds rate, resulting in annual taxable gains of approximately $1,291,667.
- The total taxable gain amount over the five years would be $6,166,668.
Partnerships
Partnerships calculate their income and losses as if they are separate taxpayers, with their partners reporting their respective portions of the income/losses according to the partnership agreement.
Special Rules for Fiscal Periods Straddling June 25, 2024
- Disclosure Requirements: Partnerships must inform partners of the amount of each capital gain, capital loss, and business investment loss realized for each period (i.e. Period 1 or Period 2) in prescribed form.
- $250,000 Capital Gains Threshold: Each individual partner's $250,000 capital gains threshold would apply for the purposes of determining the effective inclusion rate of their capital gains allocated from the partnership.
Trust Designations in Respect of Taxable Capital Gains
Canadian trusts can often designate any part of their net taxable capital gains to their beneficiaries, with the amounts maintaining their character as capital gains in the beneficiaries' hands.
- For trusts' tax years starting before June 25, 2024, and ending after June 24, 2024, the amount designated in respect of their net taxable gains are grossed up and deemed to be capital gains realized by beneficiaries in the period that the trust disposed of the relevant capital property.
- Trusts must inform beneficiaries about the portion of capital gains relating to property dispositions in each period. Failure to do so would result in all gains being deemed realized after June 24, 2024.
- Non-personal trusts, like mutual fund trusts, can elect to have the deemed capital gains realized proportionally by investors based on the duration of each period within the taxation year.
- Each individual beneficiary's $250,000 capital gains threshold would apply for the purpose of determining the effective capital gains inclusion rate for capital gains allocated to the individual by the trust.
Non-Resident Dispositions of Taxable Canadian Property
Non-residents of Canada are generally subject to tax on capital gains from the sale of taxable Canadian property, which includes real estate and certain shares. Specific procedures ensure tax collection on these gains, including a withholding requirement.
- Currently, the withholding rate is set at 25% but will increase to 35% to reflect the highest combined federal and provincial tax rates on capital gains.
- This change takes effect for dispositions occurring on or after January 1, 2025.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.