https://www.cwbwealth.com/en/news-and-stories/insights/understanding-the-impact-of-proposed-changes-to-the-capital-gains-inclusion-rate
On April 16, 2024, the federal budget proposed an increase to the capital gains inclusion rate for individuals, trusts, and corporations. With a short window until these changes are potentially brought into effect, investors might want to act promptly to review their long-term investment plans and overall tax strategy.
For the purposes of this piece, we’ll largely focus on how these changes could affect individual investors.
The most recent federal budget has proposed an increase to the capital gains inclusion rate. For individuals, this included an increase in the capital gains inclusion rate to 2/3 for any gains exceeding $250,000 within a given tax year, while the 50% inclusion rate will continue to apply on the first $250,000 of capital gains. For corporations and trusts, an increase in the capital gains inclusion rate to 2/3 will be applied across the board. These proposed changes are slated to come into effect for all gains realized on or after June 25, 2024.
For the 2024 tax year, the proposed changes will result in two distinct periods for capital gain and loss reporting.
Before June 25, individual investors, corporations, and trusts will continue to be subject to the historical 50% inclusion rate. However, on or after June 25, individuals, corporations, and trusts will be subject to the new inclusion rules outlined above. One important distinction is that the $250,000 personal limit will not be pro-rated for the remainder of the 2024 tax year. Individual investors will have access to this full amount for any gains being triggered in the latter half of 2024.
*Marginal tax rates vary by province and territory.
Visit Revenue Canada to see which rates apply to you.
For the purposes of this piece, we’ll largely focus on how these changes could affect individual investors.
What is capital gains tax?
A capital gain (or loss) arises when capital property or investments are sold for more (or less) than originally acquired. For individual investors, this would apply to any capital property except for their primary residence, or investments held in tax-sheltered accounts (e.g., TFSA, RRSP).What is the capital gains inclusion rate?
Since 2000, Canadian investors and corporations have benefitted from a 50% capital gains inclusion rate. Meaning 50% of capital gains (or losses) have been included in the computation of taxable income. For example, if an investor had a non-registered investment portfolio with a market value of $2,000,000 and an adjusted cost base of $1,000,000, they would face a capital gain of $1,000,000 upon liquidation of their portfolio. This would have resulted in taxable income of $500,000 in the year of sale.The most recent federal budget has proposed an increase to the capital gains inclusion rate. For individuals, this included an increase in the capital gains inclusion rate to 2/3 for any gains exceeding $250,000 within a given tax year, while the 50% inclusion rate will continue to apply on the first $250,000 of capital gains. For corporations and trusts, an increase in the capital gains inclusion rate to 2/3 will be applied across the board. These proposed changes are slated to come into effect for all gains realized on or after June 25, 2024.
For the 2024 tax year, the proposed changes will result in two distinct periods for capital gain and loss reporting.
Before June 25, individual investors, corporations, and trusts will continue to be subject to the historical 50% inclusion rate. However, on or after June 25, individuals, corporations, and trusts will be subject to the new inclusion rules outlined above. One important distinction is that the $250,000 personal limit will not be pro-rated for the remainder of the 2024 tax year. Individual investors will have access to this full amount for any gains being triggered in the latter half of 2024.
How will this impact individual investors?
Continuing with the example above, let’s assume an individual is from Alberta and finds themselves in the top marginal tax bracket (over $355,845 of taxable income)*. Let’s look at total taxes payable arising from a $1,000,000 capital gain before June 25 and on or after June 25:*Marginal tax rates vary by province and territory.
Visit Revenue Canada to see which rates apply to you.
What investors should consider in preparation of the June 25 deadline
In our earlier example, with $60,000 in additional tax from triggering the gain under the new tax regime, it seems like a no-brainer to pay the tax today. Unfortunately, the decision to trigger these gains is not as easy as that.
By triggering the gains today, this results in $240,000 leaving the portfolio. Over time, the growth on those funds remaining in the portfolio will eventually outstrip the $60,000 tax savings from realizing the gains earlier. Even if taxes are paid at a higher rate in the future, having more funds available to continue to grow within the portfolio will result in a net positive result for long-term investors.
By triggering the gains today, this results in $240,000 leaving the portfolio. Over time, the growth on those funds remaining in the portfolio will eventually outstrip the $60,000 tax savings from realizing the gains earlier. Even if taxes are paid at a higher rate in the future, having more funds available to continue to grow within the portfolio will result in a net positive result for long-term investors.
The short vs long-term view
Continuing with our example, let’s assume there are two investors earning a 6% rate of return on their respective portfolios. Investor A decides to trigger the full capital gain before June 25, leaving them with $1.76M in their portfolio. Investor B decides to allow their portfolio to continue growing, knowing they’ll face higher taxes in the future.
To determine which investor is better off, we must look at the after-tax value of each portfolio in any given year under the new tax rule. Since Investor A has prepaid some of their tax bill at a lower rate, they’ll be better off in the earlier years and will have less of their portfolio subject to the new inclusion rate. However, with more funds in Investor B’s portfolio, how long will it take them to surpass Investor A?
Assuming a 6% rate of return*, the breakeven point for Investor B would occur as follows:
*Assumes a 6% growth rate excluding annual taxes payable on interest or dividends received.
At a 6% rate of return, Investor B will break even in the 7th year. Over a longer-term investment horizon, this gap continues to widen where Investor B will end up significantly ahead. Over a 20-year period, this would result in a net increase of approximately $280,000, and more than $690,000 in additional savings over a 30-year period.
Based on these findings above, the decision of whether or not to accelerate the capital gains tax will be largely dependent on an investor’s time horizon. In this example, if an investor has a large liquidity event in the next seven years, they would likely be better off to realize the capital gains in their portfolio ahead of the proposed changes.
To determine which investor is better off, we must look at the after-tax value of each portfolio in any given year under the new tax rule. Since Investor A has prepaid some of their tax bill at a lower rate, they’ll be better off in the earlier years and will have less of their portfolio subject to the new inclusion rate. However, with more funds in Investor B’s portfolio, how long will it take them to surpass Investor A?
Assuming a 6% rate of return*, the breakeven point for Investor B would occur as follows:
*Assumes a 6% growth rate excluding annual taxes payable on interest or dividends received.
At a 6% rate of return, Investor B will break even in the 7th year. Over a longer-term investment horizon, this gap continues to widen where Investor B will end up significantly ahead. Over a 20-year period, this would result in a net increase of approximately $280,000, and more than $690,000 in additional savings over a 30-year period.
Based on these findings above, the decision of whether or not to accelerate the capital gains tax will be largely dependent on an investor’s time horizon. In this example, if an investor has a large liquidity event in the next seven years, they would likely be better off to realize the capital gains in their portfolio ahead of the proposed changes.
What impact will expected returns have on your breakeven point?
If Investor B were invested more aggressively, this breakeven point would occur sooner. With a $1M unrealized capital gain (at the top marginal tax bracket in Alberta), breakeven points would occur as follows:
| Rate of Return | Approximate Breakeven Point |
| 2% | 21 years |
| 4% | 11 years |
| 6% | 7 years |
| 8% | 6 years |
| 10% | 5 years |
What are some other factors to consider in this decision?
Although the general breakeven point is a good starting point for your analysis, the newly proposed legislation for individuals provides flexibility in realizing capital gains over a period of time while avoiding the punitive inclusion rate, even for those with short-term investment horizons.
In our example, let’s assume the investor is planning to liquidate the entire $2M portfolio to help a child with a downpayment in 2024 and to purchase a vacation property in early 2025. The investor could decide to trigger $500,000 of the capital gain before June 25, then $250,000 in the latter half of 2024, and the remaining $250,000 in early 2025. This will result in all capital gains being taxable at the 50% inclusion rate, while pushing out a portion of their taxes payable to April 2026.
Another item to consider for individuals is the potential exposure to Alternative Minimum Tax (AMT). Changes that were presented in the 2023 federal budget could conflict with your plans to realize large capital gains. It’s important to review this potential exposure with your tax professional.
Given that holding companies and trusts don’t have access to the $250,000 limit, this may result in the need to review triggering gains sooner.
Overall, it’s important to recognize that these changes are in the preliminary stages of their implementation and could be subject to further revisions. Investors in marketable securities have the benefit of remaining nimble, and waiting until more details are released before making changes in their portfolio. But for capital property such as real estate or business holdings – which can take longer to transact or transition – it may be time to seriously consider accelerating planned sales or succession plans.
These proposed changes further highlight the importance of a holistic approach to your financial situation including an understanding of your tax situation today and into the future. With investment income being more punitively taxed, the utilization of all available tax structures (such as TFSAs, and RRSPs), and managing capital gains exposure has become increasingly more important. Your advisor can work with you to implement tax strategies that make sense for your personalized plan, to help minimize the impact of the new rates.
In our example, let’s assume the investor is planning to liquidate the entire $2M portfolio to help a child with a downpayment in 2024 and to purchase a vacation property in early 2025. The investor could decide to trigger $500,000 of the capital gain before June 25, then $250,000 in the latter half of 2024, and the remaining $250,000 in early 2025. This will result in all capital gains being taxable at the 50% inclusion rate, while pushing out a portion of their taxes payable to April 2026.
Another item to consider for individuals is the potential exposure to Alternative Minimum Tax (AMT). Changes that were presented in the 2023 federal budget could conflict with your plans to realize large capital gains. It’s important to review this potential exposure with your tax professional.
Given that holding companies and trusts don’t have access to the $250,000 limit, this may result in the need to review triggering gains sooner.
Overall, it’s important to recognize that these changes are in the preliminary stages of their implementation and could be subject to further revisions. Investors in marketable securities have the benefit of remaining nimble, and waiting until more details are released before making changes in their portfolio. But for capital property such as real estate or business holdings – which can take longer to transact or transition – it may be time to seriously consider accelerating planned sales or succession plans.
These proposed changes further highlight the importance of a holistic approach to your financial situation including an understanding of your tax situation today and into the future. With investment income being more punitively taxed, the utilization of all available tax structures (such as TFSAs, and RRSPs), and managing capital gains exposure has become increasingly more important. Your advisor can work with you to implement tax strategies that make sense for your personalized plan, to help minimize the impact of the new rates.
The preceding information is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon as advice. Please contact your lawyer, accountant or other advisor for relevant advice. CWB Wealth Management Ltd. and its affiliates (“CWB Wealth”) takes reasonable steps to provide up-to-date, accurate and reliable information but is not responsible for any errors or omissions contained herein. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by CWB Wealth or any other person as to its accuracy, completeness or correctness. CWB Wealth reserves the right at any time and without notice to change, amend or cease publication of the information. Visit https://www.cwbwealth.com/disclosures for the full disclaimer.