Tax returns are due in about a week’s time. For those who aren’t aware, April 30th, 2018 is the deadline to file your tax returns for 2017. For those that think they might be owing the government money, it’s a good idea to get your taxes done to avoid a penalty.
Now that the deadline is so close, I’m getting a lot of questions around how capital gains taxes work. 2017 was a great year for investors. Regardless of what you actually invested in, you probably made money in 2017. Bitcoin skyrocketed. Stock markets hit all time highs. Real estate in Canada reached peak. And even weed got high.
It’s probably no surprise that so many people are confused about how capital gains taxes work. But before we get any deeper into the math, let’s remind ourselves what a few of the common things that may trigger capital gains taxes:
- Selling stocks for a GAIN
- Selling Bitcoin for a GAIN
- Selling real estate that is NOT your primary residence for a GAIN
- Exchanging and trading currency for the purpose of profiting
- Selling gold for a GAIN
There’s usually a lot of confusion whether someone needs to pay capital gains taxes. Here are a few common things you might be doing that DOES NOT incur capital gains.
- HOLDING onto stocks in a non-registered account that has GONE UP in value
- Selling your primary residence for a profit
- Collecting interest from bonds, GICs or savings accounts
- Collecting dividends from stocks in a non-registered account
- Making money on a side job outside of regular employment
- Rent collected from tenants
To make it really simple. Capital gains only applies to money earned from selling an appreciated asset that is not in your RRSP or TFSA. It doesn’t come from earning income through work or through passive income generated by holding an asset.
Preferential Tax Treatment
When it comes to taxes, the Government of Canada is the most lenient on capital gains. That’s because only 50% of the gains are taxed. Yes, that right! The government wants to encourage people to invest with their savings rather than keeping it around in a high interest savings account. That’s why investors who take the risk to invest are rewarded with a lower tax rate.
Taxable gains = Capital Gains x 50% inclusion rate
This means that for any of the above scenarios where you may have made money a gain through investments, only 50% of the gain is taxed.
As an example:
- You purchased 100 shares of a stock at $25/share. It is now $30/share and you sell. The amount that gets taxed is only $250. Exactly half of the $500 appreciation.
This special tax treatment is only available for capital gains. Nothing else.
Write Off Losses
The government recognizes that investing your money has risks involved. Sometimes the investments we make don’t pan out the way we expect it to. This means it’s possible to incur losses where the asset that was purchased has DECREASED in price.
When these money losing assets are sold, a capital loss is incurred. One thing to remember when reporting your capital gains is to subtract away all the losses from any investments that were incurred during the year.
Total gains = Sum of gains – Sum of losses
As an example:
- You made $500 buying and selling a stock that went up, but you lost $200 dollars buying and selling Bitcoin. The total gain is thus $300 ($500 – $200).
It is possible for the entire year to have your losses greater than your gains. If this happens, it still important to report these losses to the government on your tax return. That’s because losses from previous years can be claimed against gains in future years to reduce the amount of taxes you pay when you eventually do report a capital gain.
Calculate Foreign Currency Gains
One of the many mistakes that people make when reporting capital gains is to exclude foreign currency when calculating capital gains. The CRA only cares about dollar values in Canadian dollars. That means if you are buying and selling investment assets in a currency other than Canadian dollars, the conversion has to be made before reporting the gains on the tax return.
Capital gain = Purchase price of asset in CAD – Selling price of asset in CAD
Thankfully it’s possible to determine exchange rates for a variety of currencies on the Bank of Canada website. When making your calculations, it’s quite acceptable to use the Bank of Canada rates if you don’t remember what the exchange rate was for your transaction, but you have to be consistent.
A better approach to managing exchange rates is to look at your brokerage transactions and statements and find the actual Canadian dollar amount for your buy and sell transaction. In this way there’s no calculation to make so long as your statements show the amounts in Canadian dollars.
Reporting to CRA
Unlike all the other forms of income that you might earn during the year, capital gains is one of the rare forms of income where you have to calculate and report yourself. Unfortunately, brokerages don’t send you mail or forms like the T3 and T5 that tell you how much you made in capital gains. That means the onus is on you to correctly report gains to the government. Pleading ignorance is not an excuse.
If you feel that the calculation is too difficult for you to determine, then it might be worthwhile to pay an accountant to do the taxes for you. Sometimes dealing with capital gains can make our tax returns more difficult. There are also times where we may get confused what is considered a capital gain versus earned income. That’s why it’s important to double check on the CRA website if you might be confused.
Once you figure out what your taxable gains are, fill out line 127 of your tax return to report your capital gains to the government. If you are using some kind of tax software, which you should be, you should be guided by the software to correctly report the amounts.
Once you’ve submitted your amounts, most software will automatically determine the amount of taxes you’ll have to pay on your gains. Just remember that gains are taxed, but losses are not tax deductible. Losses can only be used to write off gains in the future.
There you have it. Capital gains aren’t that hard to figure out is it?