As you know, the recent Federal Budget announcement had a few important changes that can have an impact for some clients but certainly not all.
Rather than repeat the contents of the Budget, we have been spending some time on what specific actions we will be recommending for clients and why. This note outlines our thinking and hopefully will help you to get some peace of mind about whether there is anything for you to be personally concerned about or not.
One of its most significant proposals for investors is a change to the capital gains inclusion rate. Under the new rules, the percentage of capital gains subject to taxation will grow from one-half to two-thirds for any gains above $250,000 for individuals.
This change will have significant implications for anyone selling cottages, secondary residences (as you likely know, primary residences are exempt from capital gains in Canada), investment properties, stocks, or other assets.
If approved, this new capital gains rate will take effect on June 25, 2024. Here is an outline to help you understand how these changes can affect your investments, depending on your personal situation.
What to do with investments in a Corporation or Trust?
To help determine the next steps on your Corporation or Trust holdings, try our Capital Gains Tax – Hold or Sell Calculator
Personal accounts Likely no action required in most cases
Let’s say you bought $50,000 of a stock, and it has grown to $100,000. Now let’s say this holding is not in a tax sheltered account like an RRSP, RRIF or TFSA, but in a personal, taxable account.
This would mean that there is an unrealized gain of $50,000. When you sell the stock, it will be taxed.
Today, if you are in the 50% marginal tax bracket, this means that there would be $50,000 of capital gains, taxed at 50%, but because the inclusion rate is 50%, it means that effectively you are taxed 25% times the $50,000, or $12,500.
Under the new rules, or after June 25th, on the portion OVER $250,000 of capital gains in a year, you will be taxed with a 66.7% inclusion rate. So only on the portion of capital gains in a year over $250,000 would you be charged the higher rate. In the worst case, in a personal account, this would boost the tax bill on the stock sell to $16,666 or an extra $4,166.
Keep in mind that if you have a joint investment account, and you have $500,000 of realized capital gains in a year, it can be split and that would also keep it to under $250,000 each.
Not only that, but if we know about the $250,000 limit, we can generally manage around it in most situations to try to spread out gains to stay under the limit. You can even do some strategic charitable giving if you are over the limit using these shares as there is no capital gains tax on shares that are donated to charity.
This doesn’t mean that it isn’t a possible negative for personal investors, but that for the vast majority, we wouldn’t be recommending doing any sudden selling to get gains covered under the old capital gains tax rates.
There are considerations for individuals here. Selling a business could see much higher taxes. Selling a vacation property with high capital gains could see much higher taxes. These scenarios could mean someone trying to push a sell to be completed prior to June 25th, if it is feasible.
Corporations and trusts Selling some investments before new rules take effect June 25th will make sense for many
Unfortunately, the new budget doesn’t provide any protection on the first $250,000 of capital gains for Corporations and Trusts. It states that as of June 25th, ALL capital gains for corporations and trusts will be taxed with a 66.7% inclusion rate. This means that it will have some impact for every corporation and trust with unrealized capital gains.
Now what should you do?
The truth is it all depends on how long you intend to hold your asset, as well as the type of asset it is. Our new Capital Gains Tax – Should I Sell or Hold calculator can help to identify some next steps. Our analysis is focused on the option of trying to sell prior to June 25th vs. holding a security and eventually paying the higher rates later.
It appears that all things being equal, the Corporation break even will be at least a few years out for most investments. In this case it might be better to lock in capital gains prior to June 25th, unless you plan on otherwise holding the security for several years. Changes in expectations of growth, and the percentage of returns that would be made up of dividends, will impact that break even point and can be factored into the calculator.
For a Trust in Ontario, the break even would be a little longer in most cases, because the tax rate for Trusts is a little higher than Corporations.
Based on this, we would recommend being fairly proactive in reviewing and possibly selling securities with meaningful capital gains in Corporations and Trusts, and we should consider doing it in the next few weeks. We will reach out to review if this would apply to you. For securities with capital losses, they can be used against future gains, and would actually be worth more if used against future capital gains, so there is no particular pressure to sell any of those early.
An example of the capital gains impact:
$500K of capital gains today at a 53.5% tax bracket = $133,750 in today’s tax
$500K of capital gains today at a 53.5% tax bracket = $155,952 in post budget tax
Extra $22,202 in taxes
$1,000K of capital gains today at a 53.5% tax bracket = $267,500 in today’s tax
$1,000K of capital gains today at a 53.5% tax bracket = $334,107 in post budget tax
Extra $66,607 in taxes
Flow-through shares
The benefits of Flow-Through Shares will still be in place for high income Canadians and certain Corporations, but the Capital Gains increase may water down the benefits a little for those with higher income. The reason is that with Flow Through Shares the cost base of an investment is $0, and there is always a Capital Gain incurred. If these Capital Gains will put you over $250,000 for a year, then the tax impact is worse. So, for some who might buy $100,000 of Flow Through Shares, this tax change may not impact you, but for others who might have bought significantly more, it will have an impact. Each case is a little different and should be discussed. If possible, we will try to access new deals prior to June 25th to avoid the changes for this year.
The other impact relates to previously announced changes to the Alternative Minimum Tax (AMT). For those that use Flow Through Shares, the positive impact on each dollar will be the same, but you will be a little more limited in how much you can invest before the AMT comes into play.
What about real estate with significant unrealized capital gains?
The new Budget could have meaningful new taxes for those in this category.
You can try to do a sale of the property to close before June 25th, but this would be difficult to make happen, and we believe that the real estate market in cottage country may be depressed over the next couple of months because of selling pressure.
One action plan you might want to look at would be to gift your property to a family member to crystalize (and have to pay) the lower capital gains tax on unrealized gains to date.
According to a veteran real estate lawyer, their thoughts were that this is an option but a few things to keep in mind.
- If the property has a mortgage/debt, then it has to be disposed at fair market value and there would be land transfer tax owing.
- If the property is debt free and is a GIFT, it can be gifted to a family member without paying land transfer tax.
There is always the issue of whether the owner wants to give up legal control, and also the issue of family assets if there is a future problem with a son or daughter in law. - The legal costs would likely be under a few thousand dollars, but it requires two lawyers, one to act for the ‘buyer’ and one for the ‘seller’.
- You would still want to do an independent valuation of the property to provide fairness to both parties.
So…if you are older and have big capital gains on your cottage, it might make sense to change ownership in the next two months and effectively do an estate freeze on the cottage value and do it paying the lower capital gains tax. Remember, that you would need to come up with the money next spring to pay the big tax bill.
In summary, when it comes to the capital gains changes and the earlier AMT changes, the new Budget probably will not negatively impact too many people, but for those that it will impact, we will be working with you this month to sort through any actions necessary.
When it comes to tax savings, the new capital gains rates just scratch the surface.
To help determine the value of your final estate as well as the total taxes that you will likely pay over your lifetime, try our Estate Value Calculator.