This past week, Deputy Prime Minister and Minister of Finance, Chrystia Freeland, presented the Federal Budget 2024, deemed “Fairness for every generation”.
This budget focuses on measures to make buying or renting a home more affordable for Canadians, including unlocking 3.87 million new homes by 2031.
Titled "Fairness for Every Generation", the 430-page budget document offers increased student grants, an investment in Canada’s AI ecosystem, and the creation of the Canadian Entrepreneurs’ Incentive.
What garnered the most attention with the release of this budget was the increase to the capital gains inclusion rates – something that had been discussed, but not enacted, through many previous budget proposals (more on this below).
For a briefing on the highlights of the new Federal Budget, a promotional video, and a link to the entire 430-page document, please visit the link here:
As for the new capital gains inclusion rates, I’m going to first describe how the current capital gains rules are accounted for in order to contrast the change, as well as describe some of the unintended consequences of this change below.
Capital Gains under current rules:
Let’s say you purchased an asset (a property, a company, a stock, etc), and let’s assume the asset cost you $100,000 to purchase. Let’s also assume your salary is $80,000 annually.
If the asset has grown in value and is now currently worth $400,000, then you have an embedded $300,000 capital gain held within this asset.
If you were to sell it, you would need to report $300,000 of capital gains on your tax return, and under current rules, 50% of this gain ($150,000) would be taxable to you at your marginal tax rate.
If your salary was $80,000, then adding the taxable portion of this capital gain (the $150,000) would bring your taxable income up to $230,000. The difference in taxes owing for $80,000 versus $230,000 would be an additional $64,836 of taxes owing come tax time for the year.
This is how it currently works.
Under the new rules:
Using these same numbers, let’s continue to assume you purchased an asset (a property, a company, a stock, etc) at a cost of $100,000. Let’s also continue to assume your salary is $80,000 annually.
If the asset has grown in value and is now currently worth $400,000, then you have an embedded $300,000 capital gain held within this asset.
If you were to sell it, you would need to report $300,000 of capital gains on your tax return, and under the new rules, 50% of the first $250,000 of this gain and 66% of all gains thereafter would be taxable to you at your marginal tax rate.
Under the new rules, this same $300,000 gain would be broken into 2 parts:
The first $250,000 of gains would incur a 50% inclusion rate, so $125,000 would be taxable to you at your marginal tax rate.
The remaining amount of gains (in this case $50,000) would incur a 66% inclusion rate, so $33,333 would also be taxable to you at your marginal tax rate. If your salary was $80,000, then adding the taxable portion of this capital gain (the $125,000 plus the $33,333) would bring your taxable income up to $238,333. The difference in taxes owing for $80,000 versus $238,333 would be an additional $69,990 of taxes owing come tax time for the year.
The difference in taxes owing under the new rules (Scenario 2) is an additional $4,184. As you can see, the larger the gain and the higher the taxable income, (the more the gains exceed the $250,000 threshold) the larger the impact of this change.
The unintended consequences and some additional impacts to be aware of:
The changes are taking place starting June 26th 2024 (after June 25th 2024).
For those individuals with liquid stock portfolios held in taxable accounts, this certainly needs to be kept in mind to, since we can time the sale of liquid assets to be spread over multiple tax years, so as to remain below the $250,000 increase to the inclusion rates through good planning.
For illiquid assets like a property (cottage, rental, etc), you can’t sell 1 room per year to spread the gain over multiple tax years – the property is sold in its entirety. As such, the impact will likely be felt by those whose wealth is held in illiquid assets like these.
Estates will also feel the impact. When someone passes, their assets are deemed to be disposed of that day. Even if the assets are not actually sold, they are treated for tax purposes as if they were. As such, the untimely “sale” of multiple assets at the same time with no more opportunity to spread the gains over multiple tax years will likely feel the brunt of this new change.
Note that even at 66%, deferred capital gains remain the most effective manner to grow wealth, from a tax perspective. They are just less so.
Note that for corporations and trusts, there is no $250,000 threshold – EVERY dollar of capital gain incurs a 66% inclusion rate.
With this new change to the capital gains inclusion rates, you may feel the need to incur your capital gains (sell) before June 25th (and pay the taxes now) rather than face the increase in inclusion rates thereafter!
Whether or not you should sell now or later can be expressed as a function of how long you intend to hold the asset. Here is an example below:
Let's assume you have an asset that you bought for $100,000 and it is now worth $150,000 held within a corporation. We assume the corporate tax rate on passive income is 50%. We assume the corporation will hold the asset for 10 years. We assume the growth of this asset is 8% per year.
Sell the asset now to take advantage of lower inclusion rate of 50%.
The corporation would incur immediate capital gains of $50,000, half of which (50%) are taxable. At a 50% tax rate, this would mean $25,000 in taxes are owed, and the wealth of the corporation would face an immediate reduction down to $125,000.
There would be $25,000 (the non-taxable portion of the capital gain – the other 50% not included in the capital gains calculation) added to the corporation’s Capital Dividend Account (CDA) which can be withdrawn from the corporation at a later date to the individual/owner with no further tax consequences.
The remaining $125,000 of wealth within the corporation (after the $25,000 in taxes are paid) is assumed to grow at 8% for 10 years, which after 10 years would be worth $269,865.62.
The gain on the sale of the asset is calculated as $269,865.62 less the $125,000, which is $144,865.62. At a now 66% inclusion rate, the corporation would then pay taxes on $95,611.31 of the $144,865.62 in gains.
$95,611.31 at an assumed 50% tax rate would be $47,805.65 in taxes owing, and once the taxes are paid, this would reduce the wealth of the corporation down to $222,059.97.
There would be an additional $49,254.31 (the non-taxable portion of the capital gain – the other 34% not included in the capital gains calculation) added to the corporation’s Capital Dividend Account (CDA) which can be withdrawn from the corporation to the individual/owner with no further tax consequences, bringing the total CDA account to $74,254.31.
Wait to sell the asset at a higher capital gains inclusion rate.
The corporation would not incur any immediate tax consequences, and the full $150,000 would be left to accrue gains for the next 10 years.
After 10 years at an assumed annual growth rate of 8%, the wealth of the corporation would be $323,838.75.
The gain on sale of the asset is calculated as $323,838.75 less the $150,000, which is $173,838.75. At a now 66% inclusion rate, the corporation would then pay taxes on $114,733.56 of the $173,838.75 in gains.
$114,733.56 at an assumed 50% tax rate would be $57,366.78 in taxes owing, and once the taxes are paid, this would reduce the wealth of the corporation down to $266,471.97.
There would be another $59,105.18 (the non-taxable portion of the capital gain – the 34% not included in the capital gains calculation) added to the corporation’s Capital Dividend Account (CDA) which can be withdrawn from the corporation to the individual/owner with no further tax consequences.
As you can see from the example above, the longer you intend to hold the asset, the more beneficial it would be to wait to sell it – even if it means incurring capital gains at a higher inclusion rate.
If you have plans to sell an asset soon, (whether held within a corporation or trust, or in excess of the $250,000 threshold for individuals), you may want to consider doing some math sooner rather than later so see how much it is going to cost you to wait until after June 25th 2024.
I hope you find this both interesting and informative in keeping pace with today's financial world.