The federal budget released earlier this month proposed changes to capital gains inclusion rates, with officials stating that they expect only the wealthiest, or top 0.13 per cent of Canadians, will be affected by the tax hikes. But that’s not entirely accurate.
To understand why, it’s useful to consider the cases of several hypothetical Toronto investors who hold identical assets with identical accrued capital gains. Until June 25, 2024, their tax treatment would be similar, but after June 25, 2024, it will differ quite significantly.
In the budget announcement, the federal government proposed an increase to the capital gains inclusion rate for gains realized on or after June 25, 2024. For individuals, capital gains up to $250,000 will be subject to the current inclusion rate of 50 per cent, but capital gains in excess of $250,000 will be subject an inclusion rate of 66.7 per cent, or two-thirds. For corporations and trusts, all capital gains will be subject to the new inclusion rates of two-thirds.
The proposed rules favour personal (individual) ownership over corporate ownership and encourage joint ownership with family members. On June 25, the affected taxpayers will see an overnight tax hike of up to a staggering eight percentage points, taking them from the current maximum effective tax rate of up to 27 per cent to approximately 35 per cent in Ontario.
To further understand the implications, here are some examples involving both “rich” and “regular” taxpayers.
Real estate investors: Joint owner Joe, single owner Sandra, corporate owner Cam
Joe, Sandra and Cam are real estate investors in their 60s. Just like 4.4 million other Canadians, they invested in a real estate property to save for a retirement. All live in Toronto, all are married, employed full-time, and earn $100,000 a year. The three couples are comfortable financially, but it’s hard to call them “rich,” given Toronto’s high cost of living.
In 2009, the three couples borrowed money to purchase identical townhouses for $400,000 each. Luckily, their townhouses grew in value by $500,000 over the last 15 years and are worth $900,000 now. The three couples now wish to dispose of their properties to pay for their retirement.
Until June 25, the couples’ tax exposure from the sale of the townhouses would have been ranged from $112,000 to $132,000.
Starting June 25, the couples’ tax liability from the sale of their townhouses will differ quite drastically – from $112,000 to $183,000 – depending on the how they chose to hold their property when they purchased it 15 years ago. Let’s look at how each will fare under the new rules.
Joint owners Joe and Jill: $112,000 in tax, not affected by proposed rules
Joint owner Joe is married to Jill and both earn a salary of $100,000 a year. Both Joe and Jill are the owners of the townhouse. They listed the townhouse for sale and found a buyer, who is asking for a June 25 closing date.
Joe and Jill together will realize $500,000 in capital gains, but as joint owners each of them will realize $250,000, which will still be subject to tax under the old inclusion rate of 50 per cent.
If Joe and Jill close the sale on before June 24, 2024, before the proposed rules are supposed to take effect, each of them will pay approximately $77,000 in tax in 2024: $21,000 on their salaries and $56,000 on capital gains. Overall, the sale of the townhouse will result in a total tax bill of $112,000 for Joe and Jill’s family.
If Joe and Jill close the sale on or after June 25, after the proposed rules are supposed to take effect, their tax liability will not change.
Sole owner Sandra: Tax increases from $122,000 to $145,000
Sole owner Sandra is married to Sam. Like Jill in the example above, Sam earns a salary of $100,000 a year. Although the couple share finances, Sandra is the sole owner of the townhouse. Sandra listed the townhouse for sale and found a buyer. The transaction closes on June 25.
Sandra will realize $500,000 in capital gains. Only $250,000 will be subject to tax at the “old” inclusion rate of one-half, but the remaining $250,000 will be subject to the new inclusion rate of two-thirds.
If Sandra closes the sale on or before June 24, she will pay approximately $143,000 in tax in 2024: $21,000 on her salary and $122,000 on capital gains from the sale of her townhouse.
If Sandra closes the sale on or after June 25, she will pay approximately $166,000 in tax in 2024: $21,000 on her salary and $145,000 on capital gains from the sale of her townhouse.
Corporate owner Cameron: Tax increases from $132,000 to $183,000
Corporate Cameron wanted an additional limited liability protection when he was purchasing the townhouse in 2009. This is why he purchased the townhouse through a newly created holding corporation, CameronCo. CameronCo listed the townhouse for sale and found a buyer, and the transaction closes on June 25. Once sold, CameronCo will pay out the proceeds as dividends to Cameron and dissolve.
CameronCo will realize $500,000 in capital gain. All $500,000 will be subject to tax at the new inclusion rates.
If CameronCo closes the sale on or before June 24, Cameron and CameronCo together will pay approximately $132,000 in tax related to the sale of the townhouse ($48,000 corporate and $84,000 in personal tax).
If CameronCo closes the sale on or after June 25, Cameron and CameronCo together will pay approximately $183,000 in 2024 ($65,000 in corporate and $118,000 in personal tax).
Early Earl and Late Liam: Tax increase from $226,000 to $316,000
If you think Cameron is unlucky, consider the example of Early Earl and Late Liam. Earl and Liam are both 120 years old and, unfortunately, are quite unwell. Both held their lifetime savings – an investment portfolio with $1,000,000 accrued gain. Sadly, Earl passed away on June 24, and Liam passed away on June 25. Earl’s terminal return tax liability will be approximately $226,000 in tax, but Liam’s will be $316,000.
Emigrant Emmett: tax increase from $760,000 to $1,002,000
Consider also Emigrant Emmett. Unlike the taxpayers used in previous examples, Emmett is “rich” by most people’s standards. Emmett has an investment portfolio with a $3,000,000 accrued gain. He pays Canadian tax at the highest marginal rate (54 per cent). After the COVID-19 pandemic, Emmett was able to do his job remotely from countries with lower personal tax rates. Earlier this year, Emmett decided to move to the United States and booked a flight to leave Canada on June 24. Emmett will pay Canadian departure tax at the “old” rates – approximately $760,000.
If Emmett’s flight is delayed because of bad weather and he leaves at 00:01 a.m. on June 25, his tax bill increases to $1,002,000. Emmett will be very unhappy with his departure tax, but comforted by the fact that, for his future investments, the maximum capital gains rate in his new home jurisdiction in only 20 per cent (as opposed to about 35 per cent in Canada).
Conclusion
The proposed tax hike will have significant impact on many Canadians, especially those with retirement savings that must be realized all at once (either through a real disposition by way of a sale or a gift, or through a deemed disposition triggered by an emigration or death).
Without proper planning, at midnight on June 25, 2024, these Canadians’ tax exposure may increase significantly, sometimes disproportionately to that of other Canadians earning the same income.
These affected Canadians have only nine weeks left to obtain tax advice from their tax professionals, but the relevant draft legislation is not even available.
Canadians who hold their savings in investment portfolios, even the “richest” ones, will generally have control over how much capital gain they trigger every year (more than $250,000 or less) and will be less affected by the proposed rules. More planning opportunities will be available to them as opposed to real estate investors.
Anna Malazhavaya is a tax lawyer with Advotax Law Professional Corporation
Important Disclaimer
All tax dollar amounts used in the article are approximate. We are tax lawyers, not tax accountants. We used this online tax calculator for our estimations.
The case studies in this article are based on the general language used in the Budget announcement and not on the actual legislation, which is not available as of today, April 18, 2024. The proposed legislation must pass in the House of Commons and the Senate before it becomes the law.
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.
What’s the financial commitment of owning a cottage?
We want to hear from cottage owners, recent buyers, or potential buyers about the financial commitments of owning a second home. Are you a new Canadian embracing cottage culture? Did you purchase during the pandemic but are now facing financial challenges? Has remote work dynamics changed the game? Please share your experiences below, or reach out directly to Globe reporter Irene Galea at igalea@globeandmail.com.
