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How to deal with the two capital gains inclusion rates
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Jamie Golombek: Draft legislation and background released this week provide some clues
Published June 13, 2024 • Last updated 1 day ago • 5 minute read
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Deputy Prime Minister and Finance Minister Chrystia Freeland talks about changes to the capital gains tax inclusion rate during a press conference on Parliament Hill in Ottawa on Monday, June 10, 2024. Photo by Justin Tang/THE CANADIAN PRESS/
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An area that generated many questions since budget day about the proposed increase capital gains inclusion rate it is the way capital losses will be treated, especially this year when two different rates will apply.
A capital loss typically occurs when you sell an investment for less than you paid for it. For example, if you purchased shares for $10,000 and sold them for just $4,000, you would have a capital loss of $6,000. This capital loss can only be applied against other capital gains.
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First, you must apply them to other capital gains in the tax year in which the capital loss was realized. Once you have exhausted all of your current year’s earnings, you can choose to carry forward any net capital loss back and apply it to any taxable capital gains in any of the previous three years. Alternatively, they can be carried forward indefinitely and used to reduce taxable capital gains in any future year.
But how will reporting and loss reporting rules apply with the change in inclusion rates? What if a loss occurs when the inclusion rate is 50 percent, but the gain to which you want to apply that loss is at the new two-thirds inclusion rate? And how do taxpayers deal with the two different inclusion rates in 2024? The draft legislation and background released this week help answer these questions.
Under the proposal legislation passed by the House of Commons on Tuesday, net capital losses realized in other tax years are deductible against the current year’s taxable capital gains, adjusting their value to reflect the inclusion rate of the capital gains being offset. This means that a capital loss realized when one inclusion rate was applied can still fully offset an equivalent capital gain realized in a year during which another inclusion rate was applied.
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Continuing our example above, let’s say the taxpayer suffered that $6,000 capital loss in 1998 when the inclusion rate was 75 percent. This resulted in a net capital loss of $4,500. Now, let’s assume the taxpayer realized a capital gain of $6,000 in 2023 when the inclusion rate was 50 percent, resulting in a taxable capital gain of $3,000.
If the taxpayer were to claim the $4,500 1998 net capital loss as a deduction in computing his or her 2023 taxable income, the taxpayer would be entitled to a deduction of only $3,000 because the 1998 net capital loss needs to be adjusted for reflect the inclusion rate that applies to the year in which the net capital loss is deducted (2023). The result is that the $6,000 capital loss from 1998 fully offsets the $6,000 capital gain from 2023.
These adjustments may also be required when losses are applied to periods before or after the inclusion rate date change of June 25, 2024. The government has established a table of adjustment factors to be applied to the capital loss, depending on the year in which it was carried out. .
For example, if a capital loss was realized in 2023 when the inclusion rate was 50 percent and must be applied in 2024 to capital gains with an inclusion rate (for gains over $250,000) of two-thirds, the inclusion rate adjustment factor is 1.33, so a 2023 net capital loss of $50,000 becomes a net capital loss of $66,667 after June 24 ($50,000 times 1.33 ) when applied to earnings of more than $250,000.
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Let’s look at a second example. In 2025, Ali had a capital gain of $450,000, a capital loss of $50,000, and a capital loss carried forward from 2017 of $300,000. First, we calculate Ali’s net capital gain for 2025, which would be $400,000 ($450,000 minus $50,000, both realized in 2025).
The first $250,000 would be included at a 50 percent inclusion rate, resulting in a taxable capital gain of $125,000, while the remaining $150,000 ($400,000 minus $250,000) would be included at the inclusion rate of two-thirds, resulting in a taxable gain of $100,000. As a result, Ali’s taxable capital gains in 2025 would total $225,000.
If Ali wishes to apply his 2017 capital loss carried forward of $300,000 to 2025, his net gain for 2025 would be $100,000 ($400,000 minus $300,000), of which only 50% would be taxable, since it is less than $250,000. Therefore, Ali would pay tax on 50% of the $100,000 for a taxable gain of $50,000.
It’s a little more complicated for 2024, as two different inclusion rates apply for this transition year. As a result, taxpayers will have to separately identify capital gains and losses realized before June 25, 2024 (period one) and those realized on or after June 25, 2024 (period two).
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The gains and losses for the same period are first offset against each other. Taxpayers will be subject to the higher two-thirds inclusion rate for net gains in excess of $250,000 in the second period to the extent such net gains are not offset by a net loss incurred in the first period.
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Let’s say Katy realized a capital gain of $600,000 on June 1, 2024, a capital loss of $75,000 on July 25, 2024, and a capital gain of $475,000 on October 1, 2024. The gain of $ 600,000 of Katy’s period one is 50 percent taxable for a taxable gain of $300,000. Your net gain in the second period is $400,000 ($475,000 minus $75,000).
Katy would pay tax on 50% of the first $250,000 of this $400,000 gain and pay two-thirds tax on the remaining $150,000 of the gain, so her second-period gain would be $225,000 (half of the $ 250,000 plus two-thirds of US$150,000). ). As a result, your total taxable gain in 2024 would be $525,000, consisting of your $300,000 gain in period one plus your $225,000 gain in period two.
Jamie GolombekFCPA, FCA, CFP, CLU, TEP, is managing director of Tax and Estate Planning at CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.
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