The 2024 federal budget introduced a significant proposed increase to the capital gains inclusion rate from 50% to 66.67% for corporations and trusts, and for individuals on net capital gains exceeding $250,000 annually.
Effective June 25, this adjustment represents a substantial shift in tax planning strategies that can help mitigate the impact on your investment portfolio. That said, given the missing draft legislation details, uncertainty around the proposal’s interpretation and implementation, possible updates, and upcoming procedures for budget assent, Canadians are left with a myriad unanswered questions. With the deadline just under six weeks away, we’re wasting no time considering all the available strategies for your unique situation. Here are a few avenues we could explore to offer relief.
UNDERSTANDING THE CHANGE
For nearly two decades, the capital gains inclusion rate (CGIR) has remained at 50%.
Source: Government of Canada website
If the proposed budget is implemented, the change not only increases the taxable portion of capital gains but also introduces a new threshold for individuals, adding complexity to tax planning efforts.
As it stands, there will be two distinct periods for realizing capital gains in 2024. Preceding June 25, net gains realized will be taxed at the current 50% inclusion rate (Period 1). After the deadline until year-end (Period 2), individuals can realize an additional $250,000 in capital gains at the preferential 50% inclusion rate before triggering the higher rate. Trusts and corporations (whether operating, holding, or professional) will be taxed at 66.67% from the first dollar up.
REALIZING GAINS BEFORE THE JUNE 25TH DEADLINE
One immediate strategy is to sell an investment before June 25 to crystallize the capital gain and immediately repurchase it. Thereafter, depending on the client’s overall portfolio, it may make sense to strategically sell assets every year to stay below the $250,000 threshold. However, while accelerating gains can offer tax savings, it may not always align with future growth potential and long-term investment goals.
Source: RBC
If you are definitely going to dispose assets with accrued gains over the short term, it may be advisable to do so before June 25 to take advantage of the lower 50% inclusion rate. For clients who hold investments in a corporation, particularly Canadian-Controlled Private Corporations (CCPCs), harvesting capital gains early and utilizing tax-efficient capital dividends to minimize personal taxes in future years may be a beneficial strategy. However, it’s important to consider how cash flow is accessed in the corporation and whether funds originate from investment income or active business operations, distributed in the form of salaries, dividends, tax-free payments from the capital dividend account, or as a return of capital. The break-even holding period would be more or less the same as the personal calculation, but with much higher costs.
REVIEWING PRINCIPAL RESIDENCES
A valuable way to shelter gains when one or more residential properties are sold is to take advantage of the principal residence exemption (PRE). But before making any rash decisions, it’s important to look at the big picture to determine the optimal principal residence designation.
One thing many homeowners are unaware of is that their PRE doesn’t necessarily have to be the home they live in most of the year. Any personal-use residential property can be a principal residence if the homeowner, their spouse or common-law partner, and/or an unmarried minor child lived in the home at any point during the year.
Generally, it makes sense to designate the PRE to the property with the larger gain to maximize tax savings. However, this may not be clear until you actually sell one of the properties. Should the second residence yield a higher gain than the first, your tax position could be less favourable if you already claimed the PRE.
Take the example of a couple looking to downsize in retirement by selling their city home for $1.4 million (purchased in 1990 for $250,000) and a cottage for $1.1 million (acquired in 2005 for $600,000).
At first glance, using the principal residence exemption on the city home makes sense since that gain is higher. However, the city home was their only residence from 1990-2005. By exempting those years, the taxable portion of the $1.15 million gain is reduced to just $345,000. Meanwhile, the entire $500,000 gain from the cottage would be taxable. So in this case, it is more beneficial to designate the cottage as the principal residence to shelter more of the total gain.
REEVALUATING TIMELINES
Before taking action, it’s important to pause and think about your unique situation. Has your investment horizon changed? Are your goals still the same? Has your risk tolerance changed? Do you need liquidity in the short term? Will your taxable income change in the near future? Is life expectancy a factor to consider when finding solutions to minimize tax implications on your estate?
At the end of the day, our clients should carefully evaluate how long they plan to hold a property and notify us if there’s a big likelihood of being subject to the higher inclusion rate in the year they plan to sell. Remember, the longer you plan to hold an investment and the greater the anticipated return, the less advantageous it may become to sell prematurely to benefit from a lower inclusion rate. Realizing gains early essentially means prepaying taxes, which reduces the amount of capital available for future investments.
Another aspect to consider is whether the entire portfolio has a capital gain turnover above $250,000 on a year-by-year basis as opposed to certain years with trigger-specific scenarios. Importantly, a substantial capital gain before June 25 could also incur Alternative Minimum Tax if the capital gain represents most of your income for the year. These are all factors to consider when planning a holistic strategy best suited to your unique circumstances.
BOTTOM LINE
With the significant capital gains tax increase on the horizon, there is a limited window to review investment portfolios and implement strategies to crystallize gains or transfer properties. We are carefully monitoring the situation and modelling solutions to minimize our clients’ tax liability while still aligning with their broader financial goals. If you have any questions or concerns, our door is always open.