Of all the questions MoneySense receives (and we get a lot), the most popular is “How can I avoid capital gains taxes?” No wonder: capital gains taxes can take a big bite out of your wealth. It seems unfair that you have to fork over money to the government just for investing well, and most of us would rather run across hot coals than pay them.
The good news is that unlike regular income, only 50% of capital gains are taxable. Plus, you don’t have to pay until you sell the asset. Bottom line is—despite their bad rap—capital gains can actually be the most tax-friendly of all investment returns, and there are plenty of ways to defer, reduce or even avoid them altogether. Read on as we answer the most pressing capital gains questions sent to us by MoneySense readers.
Q. Can I avoid capital gains taxes by gifting assets to a family member?
Usually not, though you may be able to defer them. Normally, when you give assets such as stocks or property to someone, you trigger a “deemed disposition.” This means that even though you didn’t actually sell the asset (you just gave it to someone else) you’re on the hook for capital gains taxes as if you had sold it at its fair market value.
The one notable exception is gifting between spouses or common-law partners, which does not trigger a deemed disposition. But be aware of the Canada Revenue Agency’s attribution rules: when assets are gifted to a spouse, all interest, dividends and capital gains (or losses) are attributed back to the gifting spouse. So if you were to give $10,000 worth of shares to your husband, no tax would be payable immediately. But when he eventually sells them, you’d be responsible for any capital gains taxes due.
There is one way to legally avoid or reduce capital gains taxes if two spouses have a huge difference in income: the high-income earner can loan money to the low-income partner, who can use it to buy investments. (You must charge the CRA’s prescribed interest rate, which is currently 1%.) Unlike gifts, spousal loans do not trigger the attribution rules, so the low-income spouse will be responsible for paying any capital gains taxes at a lower rate.
Q. Can I use capital losses from past years to offset future capital gains?
Absolutely. If you realize a capital loss (by selling an asset for less than you paid for it) you can use that loss to reduce any capital gains you had on other assets that year. After that, you can use any remaining capital losses to offset gains you reported in any of the previous three years (you’ll need to submit a request to CRA).
Additionally, you can carry forward capital losses indefinitely, which means you can use them to reduce capital gains you might realize in the future. If your income is likely to be higher in later years, carrying your capital losses forward can be a smart move.
Say you’re a stay-at-home parent who plans to return to work, or you’re in the early years of retirement and haven’t yet started drawing down income from your pension, Old Age Security or RRSP. You might want to carry forward your capital losses for a while and use them to offset gains you will realize in future years when you’re in a higher tax bracket, so your tax savings will be greater. “Sometimes I encourage people to bank capital losses, even if they have capital gains, because they’re going to be in a higher tax bracket in the future,” says Jason Heath, a fee-only certified financial planner and income tax professional at Objective Financial Partners in Toronto. “If you can save $2 next year instead of $1 today it’s worth it to hold onto it.”
Q. Can I claim capital losses in my TFSA to offset gains in a non-registered account?
Nope. You can’t claim a capital loss on any investment held in a tax-free or tax-deferred account like a TFSA or an RRSP.
Q. Is there any way to get around the “superficial loss” rule?
To prevent investors from selling an asset to claim a capital loss and then buying it back right away, the CRA created the superficial loss rule. It applies when you claim a loss on a security and purchase “identical property” within 30 calendar days before or after the sale. For example, if you sold shares in Royal Bank at a loss and then bought more shares of the bank a week later, your capital loss would be denied. And don’t think you can have your spouse or someone affiliated with you (like a business partner) repurchase the same stock, either: the CRA will still disallow the loss.
Luckily, there is a way to legally avoid the superficial loss rule: You can repurchase a security that is similar, but not identical. For example, you could sell a Canadian equity ETF when it’s showing a loss and then buy another Canadian equity ETF that tracks a similar but not identical index. “That way you can realize a capital loss and still maintain similar exposure to Canadian stocks in your portfolio,” says Justin Bender, a portfolio manager at PWL Capital in Toronto.
Q. Is there any way to avoid capital gains entirely?
There are three ways to completely avoid capital gains—all of which are either unrealistic or unappealing.
The first is to become immortal and never sell your assets: dying, inconveniently, requires you to dispose of all your capital property (unless it transfers to your spouse with a tax-free rollover). A second strategy is to have an abysmal investment portfolio that never grows in value. Finally, you could earn little or no income, since the “basic personal amount” allows us to each earn about $11,000 a year without paying federal taxes.
As Toronto tax lawyer Eldad Gerb puts it, “If you’re avoiding capitals gains altogether, things are probably going pretty badly for you.”
There is one appealing way to avoid capital gains taxes, assuming you were planning on leaving a legacy. “You can donate capital property with unrealized gains to a registered charity,” says wills and estate planner Nathan Bender of Scotiatrust in Toronto. “The unrealized gains will be deemed to be nil and the donor would be entitled to the donation tax credit based on the fair market value of the property at the time of transfer.”