Capital gains changes in Canada and how life insurance helps

The federal government’s proposed changes to capital gains taxes have received mixed reactions from the Canadian public and finance experts alike. While the conversations about the government’s proposal will continue to flash on our news screens, we’ve taken this opportunity to decode what the changes are and how they can impact corporations and individuals. 

What are capital gains?

Capital gains are the profit you make when selling a valuable asset. When you sell something of value—real estate, stocks, bonds, ETFs, bonds, cryptocurrencies, or  other investments—for an amount that is higher than the price you originally paid for it, the profit you receive is a capital gain. 

Currently in Canada, when you make a profit on the sale of an asset (other than your principal residence), half of that is counted as taxable income. Simply put, you pay taxes on 50 percent of your capital gain. 

The newly proposed changes to capital gains taxation are about to alter this. 

What is the inclusion rate for capital gains in Canada?

In Canada, the inclusion rate refers to the percentage of capital gains that are included in an individual’s taxable income for the year. Prior to the recent announcement, the inclusion rate for capital gains in Canada was 50 percent. This meant that only half of the capital gains are subject to taxation.

For example, if you have a capital gain of $500,000, only $250,000 of that gain would be included in your taxable income. The proposed alterations to capital gains taxes are about to change this.

What are the proposed capital gains tax changes?

Starting June 25, 2024, the government has proposed to increase the capital gains inclusion rate from 50 percent to 66.7 percent for any profits above $250,000. Instead of just half, they’ll count two-thirds of your profit as taxable income. 

While this change applies to all the capital gains a corporation or trust makes on or before June 25, 2024, there are some differences to how it will affect individuals. 

How will the changes in capital gains taxation affect individuals?

Individual taxpayers would continue to pay tax on 50 percent of their capital gains up to $250,000, even after June 25, 2024. For any capital gains beyond $250,000, the individual will have to pay taxes according to the new rate of 66.7 percent. Here’s a breakdown of what will happen before and after June 25, 2024:

The rules don’t change—as an individual taxpayer, you will pay tax on 50 percent of your capital gains of up to $250,000.

The new capital gains taxation rules will apply. While you will continue to pay tax on 50 percent of your capital gains of up to $250,000. Anything beyond that will be taxed at 66.7 percent.

Let’s understand with the help of an example.

John, an individual taxpayer, bought two assets worth $500,000 each in December 2022. He sold the former for $1,000,000 in January 2024 and he plans to sell the latter also for $1,000,000 in July 2024. 

Period 1 (Capital gains realized before June 2024)

For the first asset:

• John’s profit, or capital gain, is $500,000
• He will be required to pay taxes on 50 percent of the capital gain which is $250,000

Period 2 (Capital gains realized after June 2024)

And for the second asset:

• His capital gain is also $500,000
• Should the proposed changes come into effect, he will have to pay taxes on 50 percent of  the first $250,000 of capital gain i.e. on $125,000
• He will need to pay taxes on 66.7 percent of the remaining capital gain of $250,000 that is on $167,500
• So total amount of taxable income from the second sale will be $292,500

How will the changes in capital gains taxation affect corporations?

The proposed capital gains tax changes will increase the inclusion rate to 66.7 percent from 50 percent without a $250,000 limit for corporations. This means that regardless of the amount of profit on the sale of an asset, corporations will pay tax on two-thirds of their capital gains. 

The new rules can affect corporations eligible for the Small Business Deduction. Currently, small businesses making under $500,000 of business income qualify for lower tax rates. However, if a company earns over $150,000 from investments, it can lose this tax advantage. If the Capital Gains Inclusion Rate (CGIR) rises, companies might reach this $150,000 limit faster, resulting in fewer or no tax breaks, causing concern for them.

How do the proposed capital gains tax changes affect individual homeowners?

Any real estate (apart from your primary or principal residence) that you sell after June 25, 2024, will fall under the proposed capital gains taxation. This means that any profit that you make beyond the designated $250,000 will be taxed at 66.7 percent inclusion rate. 

To clarify, your principal residence, which is where you live for most of your life, is exempt from capital gains taxes. Regardless of how much you profit on the sale of your principal residence, you will not have to pay capital gains taxes on it. 

How does the proposed capital gains tax affect estate plans?

Reviewing estate plans is important following the Budget 2024 because it didn’t clarify if there will be exceptions for capital gains upon death, as per the proposed changes. Currently, when a taxpayer dies, all their assets are considered sold at market value, leading to capital gains taxes. This is called deemed disposition. 

With the proposed changes, these taxes on deemed disposition might also increase. Therefore, it’s advisable for individuals to reassess their estate plans considering the potential higher tax burden upon death.

What can you do to minimize losses due to these new rules?

While evading taxes is simply not an option and is a criminal offense, there are ways to legally pay the least amount of tax possible: These are:

Can life insurance help offset the increased inclusion rate with the proposed capital gains changes?

Absolutely! Permanent life insurance is a non-taxable way to build and generate wealth over time. With permanent life insurance, policyholders can pay more than just the premiums. The additional funds are invested and continue to grow over time and generate cash value. 

Permanent life insurance policyholders also get additional benefits, including:

Life insurance and the proposed capital gains tax rate: An example

John and Emily own a primary residence and a rental property. Upon John’s passing his assets transfer to Emily. When Emily also passes away, the assets go to the children, but trigger a deemed disposition capital gains tax.

In this scenario, without adequate estate planning, the children might face challenges to pay the increased tax liability, such as needing a bank loan or selling assets to pay taxes. Life insurance could provide a solution. 

John and Emily could buy a life insurance policy with a death benefit equal to the projected tax-liability their children might incur upon inheriting the business. The new life insurance policy can provide the following benefits to the family:

Read more about the tax implications of life insurance

We’re here to help! 

We know all of this can sound overwhelming, so we’re here to help. Our expert and licensed advisors will help you understand the impact of the new capital gains taxations on your assets. Schedule a call with us today!