How to (Legally) Avoid Capital Gains Tax in Canada

By Emily Southey | 15 minute read

Are you a real estate investor who wants to know how to avoid capital gains tax in Canada? You’ve come to the right place. Keep reading to learn all about how capital gains tax works in Canada and our top tips on how you can keep more of your money while still complying with Canadian law. 

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Capital Gains Tax in Canada

As a real estate investor, it’s crucial to be aware of Canada’s tax structure. This will help you understand the true cost of your real estate investment. In Canada, some residential property sales are subject to capital gains tax. Capital gains tax is a type of tax real estate investors may owe to the federal government when they make a profit from selling an investment property (capital gains tax is also applicable on the sale of other assets, such as stocks and bonds). Please note that capital gains tax only applies if you earn more from the sale than you originally paid. For example, if you are an investor who purchased an investment property for $600,000 and then sold it for $850,000 two years later, your capital gain is $250,000 (the difference between the purchase price and the original sale price). On your next income tax return after the property sale, you must report this amount, along with your other income.

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Capital gains tax does not apply to all property sales. However, in most cases, it applies to investment property sales (that is, properties that are not considered principal residences). Therefore, if you are selling an investment property, you will likely need to pay capital gains tax. However, if you are selling a principal residence, you will not. The key differences between principal residences and investment properties are outlined below. 

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Principal residence defined

The Canada Revenue Agency (CRA) defines a principal residence as follows: 

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• It is a housing unit, a leasehold interest in a housing unit, or a share of the capital stock of a co-operative housing corporation you acquire only to get the right to inhabit a housing unit owned by that corporation;
• You own the property alone or jointly with another person;
• You, your current or former spouse, your common-law partner, or any of your children lived in it at some time during the year; and
• You designate the property as your principal residence.

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Please note that your property is required to meet all four of the conditions listed above to be considered a principal residence. It’s also worth noting that according to the CRA, a principal residence can be any of the following types of properties: house, cottage, condominium, apartment, duplex, trailer, mobile home, or houseboat.

When do you pay capital gains tax on a home sale in Canada?

Now that you know what qualifies as a principal residence and therefore exempts you from paying capital gains tax in Canada, let’s dive into the scenarios in which a property owner would be required to pay capital gains tax. If any of the following is true, you should prepare to pay capital gains tax on your property sale. 

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• The property was not your principal residence (that is, it did not meet the criteria listed above).
• The property was used for business purposes. 

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Are there exemptions to paying capital gains tax on a home sale?

Yes, there are a number of exemptions to capital gains tax in Canada. As alluded to above, the main exemption is the principal residence exemption. Primary residences are tax-exempt in Canada. Another capital gains tax exemption is for farm and fishing properties. If you own a farm or fishing property and sell either for a profit, the amount you earned on the sale is exempt from capital gains tax (up to a limit of $1 million). To take advantage of this tax exemption, your farm or fishing property must meet the following conditions:

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• Shares of the capital stock of a family farm or fishing corporation owned by you, your spouse, or your common-law partner;
• An interest in a family farm or fishing partnership owned by you, your spouse, or your common-law partner;
• Real property including land, buildings, and fishing vessels; and
• Property included in capital cost allowance Class 14.1, such as milk and egg quotas, or fishing licences. 

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How Do Capital Gains Work in Canada?

To understand how capital gains work in Canada, we are going to break down capital gains and losses. A capital gain is the amount that an investment increases in value. This investment could be a property or another type of asset, like a stock, bond, or mutual fund. If the value of the asset increases from the time you bought it, it qualifies as a capital gain and you will need to pay tax on it when you sell it. A capital gain can be further broken down into realized or unrealized capital gains, the former being when a capital gain occurs after selling the investment and the latter being when your investment has increased in value but you have yet to sell it. The good news? Real estate investors in Canada are only required to pay tax on realized capital gains. 

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A capital loss is when the value of your investment decreases in value since it was purchased. For example, if the current value of your rental property is less than the original purchase price, it is considered a capital loss. While most investors prefer to avoid capital losses, the bright side is that they can be used to offset capital gains and reduce the amount of tax you pay. 

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Capital gains tax rate in Canada

The capital gains tax rate in Canada is not as simple as HST or GST. Rather, it relates to income tax. When you sell an investment at a profit, 50% of the capital gain is taxable. If you sell an investment property, you will need to add 50% of the capital gain to your income on your next income tax return. Therefore, the exact amount of capital gains tax you will owe varies as it depends on your other sources of income. Further, it will also depend on if you have any capital losses to offset the capital gain. 

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How Are Capital Gains Calculated in Canada?

As mentioned, real estate investors are only required to pay tax on 50% of their realized capital gain(s). In essence, only half the profit you earn from a property sale is taxable, while the other half goes right into your pocket.  

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To calculate the capital gains tax on a property sale in Canada, you must subtract the adjusted base cost (ABC) of the property from the sale price. To determine the ABC of the property, you will likely need to do some additional calculations. Please note that the ABC is the original purchase price of the home, including legal fees, taxes, commissions, and any upgrades or improvements made to the property. So to calculate your ABC, you must add up all of these expenses and then subtract the total from the sale price of the property. Next, divide that number in half and the amount you are left with is the amount subject to capital gains tax in Canada (that is, the amount that must be added to your overall income and reported on your income tax return). Since capital gains tax is tied to one’s income and the specific amount of profit earned, the amount owed varies significantly.

Eight Tips to Avoid Capital Gains Tax in Canada

As a real estate investor, it might be impossible to avoid paying capital gains tax in Canada. That said, there are ways to minimize how much you pay or defer payments. The experts at Wahi have put together a list of tips to help you pay less capital gains tax when selling an investment property in Canada. 

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1. Sell your investment property when your income is at its lowest

Since the amount of capital gains tax owed is dependent on your tax bracket (and the corresponding tax rates in your province or territory), one trick to paying less tax is by selling your property when your income is at its lowest. By doing this, your capital gains tax rate will also be lower, which translates to more money in your pocket. Not everyone’s income will fluctuate, but if you or your partner are on parental leave or taking a leave of absence from work, selling your investment property during this time could minimize how much capital gains tax you are required to pay. 

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2. Offset capital gains with capital losses

As mentioned above, the CRA allows taxpayers to offset their capital gains with their capital losses. So if you recently suffered a capital loss, whether a previous investment property, stock, or bond sold for less than you purchased it for, you could use these capital losses to your advantage. As with a capital gain, a capital loss is only realized once the asset has been sold. Therefore, if you decide against selling your investment property because you know it will be sold at a loss, your capital loss is unrealized and cannot be used to offset a capital gain. It’s worth noting that investors can apply their capital losses to any capital gains made in the past three years. Meaning if you don’t have any capital gains to offset in the same year you had a capital loss, you can wait and retroactively apply your capital loss to a future capital gain as long as the loss occurred in the three years prior. 

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3. Donate your investment property to charity

Another tip for reducing how much capital gains tax you pay in Canada is to donate your property to charity. Donating your investment property to a registered charity of your choice is a quick way of reducing your capital gains tax. If the property you donate results in a capital gain, you won’t have to pay any capital gains tax. Instead, you will benefit from a significant tax deduction. 

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4. Track all expenses associated with your investment property

Tracking all expenses associated with your investment property is another way to ensure you never pay more capital gains tax than you have to. Since certain expenses, such as legal fees, are considered part of your adjusted base cost and therefore used to calculate how much you owe, maintaining a record of all spending can help minimize how much capital gains tax you owe. Examples include retaining copies of receipts and invoices for legal fees, property taxes paid, and home improvements or renovations, such as landscaping, new window treatments, new garages or driveways, and HVAC installations. These are all examples of expenses that can impact your capital gains tax.