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6 capital gains tax myths debunked

Canada Revenue Agency National Headquarters

Every year there are questions. Questions about how to calculate capital gains tax owed. Questions about what triggers capital gains tax. And dozens and dozens of questions on how to avoid paying capital gains tax, which include many capital gains tax myths.

To recap, a capital gain occurs when you sell an asset for more than you paid for it. Capital gains trigger capital gains taxes, which apply to the property known as capital assets. These can include stocks, bonds, jewelry, coin collections, art, and your principal residence, among others.

The problem is that nobody likes getting this big tax bill, even if the profit earned is a sizeable sum. Many Canadians try and find ways to minimize or even avoid paying capital gains tax. The result is that there are some less than legitimate ways to deal with capital gains — and some pretty strong myths that just muddy the waters.

To help sort through the mess, we’ve identified and debunked six capital gains tax myths.

Myth #1 – “If I don’t live in my home long enough, I’ll have to pay capital gains tax on the sale price.”

Home-for-sale-sold-sign-help-for-first-time-buyers

This is probably one of the most pervasive myths in Canadian tax folklore. I’ve had friends and neighbours swear to me that a person has to stay in a home for at least six months (or nine months, or 18 months, or however long) in order to avoid paying capital gains tax on the profit from the sale of their home.

Wrong.

The Canada Revenue Agency (CRA) is very clear: There are no timeline requirements that designate a home as a principal residence. That means you could buy, live and sell your home within a three week period, and, as long as it’s your principal residence, any profit earned on that sale is sheltered by the principal residence exemption (PRE).

Of course, a few flippers realized that this was a great way to avoid paying tax (both income tax and capital gains tax) and started using the PRE to earn tax-free profits. Half a decade ago, the CRA started cracking down hard on this behaviour — flagging anyone that appears to buy, renovate and move from their ‘home’ on a fairly frequent basis.

Still, for anyone faced with the possibility of having to sell the family home, particularly after living in the property for a short period of time, can take solace in the fact that the sale of the property won’t trigger capital gains tax owed.

Myth #2 – “Use the joint investment account to reduce my capital gains tax bill.”

Senior couple meeting financial adviser for investment

Some investors believe that using a joint account will help the higher-income earner to reduce their tax bill. The strategy is to get the higher-income earner to claim any and all losses, in order to reduce any capital gains taxes owed. At the same time, the lower-income earning spouse will report the gains from the investment account and pay any taxes owed, based on their lower marginal tax rate. 

Sounds great, right? Only, it’s a myth.

Any income earned from a joint account must be reported by all parties who earned the money. That means, when a couple shares an investment account, both must report their share of the earnings along with their share of the gains. Typically, that works out to a 50/50 split. But not always. 

If one spouse contributes more then the earnings and losses must be allocated according to the amount of capital provided by each investor. In other words, if you fronted 90% of the capital towards a joint investment, you must pay 90% of the taxes owed on the investment earnings. 

Myth #3 – “I can reduce the capital gains tax owed on my home’s rental suite by claiming capital cost deductions (CCA).”

Couple with calculator choosing mortgage rates. Lock in mortgage rates

This isn’t a myth. You can reduce the capital gains tax owed on your home’s rental suite by claiming capital cost allowance deductions. But you shouldn’t.

As stated, your home’s capital gain — the profit earned on the difference between the purchase and sale price — is sheltered by the principal residence exemption (PRE). However, to qualify for this exemption, you must use the property as your primary home. If you have a rental suite, that portion of your home cannot be sheltered from taxes owed.

To illustrate, let’s assume you purchase a 2,000-square-foot home for $350,000 and immediately turn your basement into a rental suite. The basement suite takes up 40% of your home’s living space, leaving 60% for your use.

Now, let’s assume you sell the home three years later for $425,000. If you didn’t have the basement suite, the $75,000 in profit would be tax-free. You’d have to report it, but you wouldn’t owe tax on it.

But because you have the basement suite, you’ll have to pay capital gains tax on 40% of that $75,000. (The exact amount is based on your marginal tax rate.) If you are in the 33% tax bracket, you’d owe $9,900, on the $30,000 in profit that is attributed to the basement suite.

That seems like a lot. But here’s the kicker, if you claim CCA on your basement rental suite, in order to reduce your capital gains and the taxes owed on these gains, you negate your ability to shelter the home’s sale profit using PRE. That’s because the CRA considers CCA deductions as a business-related expense. If you claim this expense, you are essentially telling the CRA that your property is a business, not a primary residence.

Myth #4 – “I can hide my day-trading earnings inside a TFSA.”

TFSA saving for a down payment

Another common tax myth is that Canadians are able to hide investment gains from day-trading inside a Tax-Free Savings Account (TFSA). 

This is a myth and one that can cost a taxpayer quite a lot. 

According to the CRA, taxpayers are not legally allowed to use their TFSAa for any type of business activity — and this includes the business of trading stock (or other investment assets). 

In 2018, the CRA started to crack down on a few large TFSA account holders, who appeared to be using their TFSA as day-trading accounts. 

Myth #4 – “I can avoid paying capital gains tax if I reinvest the profits.”

For Sale Reduced price sign Zolo
Peach Arch News

Every year, someone writes to ask me whether or not this strategy can be used to avoid paying capital gains tax. This year, a reader asked:

“Can I avoid [a] capital gain[s tax that] arises from the disposition of a rental property investment if I replace it with another rental property?

Quick answer: No.

Long answer: You never could.

Where did this myth come from? It came from personal finance advice generated by American writers and experts.

Turns out the American tax system treats capital gains and investment earnings quite differently than the CRA. According to Investopedia:

The tax you’ll pay on a capital gain depends on how long you held the asset before selling it. To qualify for the more favorable long-term capital gains rates, assets must be held for more than one year.

Any gains on assets you’ve held for one year or less are short-term capital gains, which are taxed at your higher, ordinary income rate. The tax system in the United States is set up to benefit the long-term investor. Short-term investments are almost always taxed at a higher rate than long-term investments.
But the CRA doesn’t see a difference between capital gains on an asset held for a long time or a short time and it doesn’t give taxpayers a break if they opt to reinvest any profits earned from the appreciation of an asset.
For real estate investors, there are some strategies to minimize the tax owed on the sale of a rental property, but selling one investment property to purchase another one will not let you avoid paying capital gains tax.

Myth #5 – “I don’t have to pay capital gains tax on my real estate rental as long as I live in it, too.”

Couple-reviewing-home-renovation-plans-Zolo

We all love the idea of earning free money.

But this lofty goal rarely, if ever, exists (unless, of course, you win the lottery) and it certainly means you can’t earn money on a rental suite and avoid paying capital gains on that portion of your house.

It also means that you need to be very clear about what portion of your home is rented and what portion is used as a principal residence. You then need to realize that the rental portion of your home will have taxes owed once the property is sold (thankfully, the primary residence portion won’t owe tax).

Myth #6 – “I don’t want to get rid of our home’s rental suite because I can’t afford the capital gains tax I’d need to pay.”

capital gains tax. Canada Revenue Agency

In theory, whenever you change the use of a property, the CRA considers this a deemed disposition — or as good as sold. Any property (or real asset) that is sold for a profit will trigger capital gains tax, even a primary residence, only the tax owed on a primary residence is sheltered using the PRE.

Theoretically, then, if you stop using the rental suite in your home as an income-producing venture, you’ve changed the use of that suite and, technically, the CRA considers the unit sold and you owe tax on that theoretical sale. The good news is that the CRA does not require homeowners to pay capital gains immediately on a property with a deemed disposition. Instead, a homeowner can defer the payment of these taxes until the actual sale of their home.

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Romana King

Romana King is an award-winning personal finance writer, real estate expert and the current Director of Content at Zolo Homebase. Romana has contributed to business and lifestyle publications including CBC.ca, Toronto Sun, Maclean’s, MoneySense, Globe & Mail Custom Content Team, and The Toronto Star. Among her achievements, Romana won silver for her annual Where to Buy Now real estate package in the 2019 Canadian Online Publishing Awards. In 2015, she won a SABEW Business Journalism award. When she was editor of CI Top Broker, Romana helped guide her team to obtain its first KRW Business Journalism nomination, and in 2011, she was part of a small team that helped MoneySense win Magazine of the Year at the 34th annual National Magazine Awards. Her north star is to consistently provide actionable, valuable and accurate information that helps elevate the financial literacy of everyone.