Physician's Guide to the Capital Gains Tax Proposed Changes

The 2024 federal budget has put forth a proposal to increase the capital gains tax inclusion rate for individuals and corporations. These changes carry significant weight for physicians, particularly those who operate their practice as a professional corporation and invest surplus income in areas like real estate. It is crucial to explore the intricacies of capital gains and comprehend the potential impact of these proposed changes, empowering you to make informed decisions.

What are Capital Gains?

Capital gains are the profits realized from selling or disposing of capital assets such as stocks, bonds, real estate, or other investments. When you sell a capital asset for more than its adjusted cost base (ACB), the difference between the sale price and the ACB is considered a capital gain. For instance, if you bought a condominium in Toronto for $600,000 in 2019 and sold it for $900,000 in 2023, a capital gain of $300,000 would be triggered.

How Are Capital Gains Taxed in Canada Currently (Individually and in Corporations) and Proposed Changes

Before the proposed changes, only 50% of capital gains were subject to taxation for both individuals and corporations. In the given example, $150,000 ($300,000 X 50%) of the gain would be taxable.

For individuals, the tax rate applied to this would vary depending on your position within the federal and provincial income tax brackets in the year of reporting the gain. If you find yourself in the 53.53% marginal tax bracket-the highest federal and provincial (Ontario) combined rate in 2023, the gain is added to your income, and you would personally pay $80,295 ($150,000 X 53.53%) in taxes.

For corporations, income from an investment is treated as passive income and is taxed at a combined federal and provincial (Ontario) rate of 50.2% for 2023. Hence, if the gain is realized in a corporation, the tax impact would be $75,300 ($150,000 X 50.2%).

Budget 2024 proposes the following changes:

• For individual investors, on capital gains that exceed $250,000 per year, a new 66.67% inclusion rate will apply. If you sell a property for a gain under $250,000, the gain subject to taxation will be at the more favorable 50% rate. However, any gain above $250,000 will be subject to an inclusion rate of 66.67%.  In our example above, with the change, the tax impact would be $84,757 ($250,000X 50% X 53.53%) + ($50,000X 66.67% X 53.53%).

• For corporations and trusts: The capital gains inclusion rate of 66.67% applies to all capital gains, regardless of the amount. This means corporations holding real estate as investments will see a bigger tax bite. Instead of 50% of the gain being subject to tax, 66,67% of the entire gain will now be taxable. In our example above, with the change, the tax impact for a corporation would be $100,405 ($300,000X 66.67% X 50.2%).

The calculations above demonstrate the significant impact these changes can have, depending on the gain expected to be incurred and whether the asset is held individually or within a corporation.

Strategies to Minimize Capital Gains Tax

With the proposed changes coming into effect, some planning strategies can help you minimize the tax burden on your real estate related investments:

• Utilize the principal residence exemption: A home that has been used as your primary residence is exempt from capital gains tax, subject to meeting specific criteria set out in the Income Tax Act. This is a crucial benefit for Canadian homeowners and the budget changes do not impact this exemption.

• Understand how capital gains are calculated: It is important to know which expenses to include when calculating a capital gain. This knowledge can help you minimize your tax obligations and maximize your after-tax returns on investments. If you are selling a property, for instance, you may be able to deduct the cost of renovations, transfer taxes, and legal fees from the proceeds of disposition. This can help reduce capital gains from real estate sales.

• Make use of the capital gains reserve: If you receive payment for your property over several years, rather than the entire payment upfront, you may be able to claim a reserve. A reserve allows you to report a portion of the capital gain in the year you receive the proceeds and defer the gain incurred to future years. This effectively allows one to split the gains reported over five years, a strategy especially useful considering the $250,000 ceiling on the capital gain inclusion for personal payers.

• Consider holding investments in tax-sheltered accounts: Investments held in registered accounts such as registered retirement savings plans (RRSPs) or tax-free savings accounts (TFSAs) are tax-sheltered. This means your investments can grow in value tax-free. With TFSAs, funds can also be withdrawn tax-free. Capital gains earned on income in an RRSP are not taxable when the gain is realized but rather when the funds are withdrawn.    

• Claim capital losses: Capital gains can be reduced by offsetting them with capital losses, which can lower your tax obligation. The Canada Revenue Agency (CRA) allows you to carry net capital losses back up to three years, meaning that if you have lost money on investments, you can use those losses to offset any capital gains from previous years. If you have no capital gains in the current or previous three tax years, you can choose to carry your losses forward indefinitely and use them to offset any gains you may have in the future. Planning ahead and disposing of assets strategically in specific years can help reduce your overall tax burden for that year.

Given the complexity of tax law and the numerous factors involved, a comprehensive cost-benefit analysis is highly advisable before making any decisions ahead of the June 25, 2024, deadline. Taxpayers need to take into account the possible unexpected tax outcomes, which might surpass the tax advantage of realizing a profit prior to the rise in the inclusion rate. These include the rules related to residential property flipping rule and the alternative minimum tax for individuals and corporations. Reaching out to a tax advisor promptly is crucial for physicians to assess the potential impacts of proposed capital gains tax inclusion rate changes on their personal finances, trusts, and corporations.