On April 16, Finance Minister Chrystia Freeland delivered the 2024 federal budget. There are many new spending initiatives within the budget, and, simply put, to pay for these initiatives, they must raise tax revenues. One way the government has addressed this is by increasing the capital gains inclusion rate for individuals, corporations, and trusts, with an effective date of June 25, 2024.
One of the benefits of investing in equities and real estate is the ability to defer capital gains until sold. This deferral provides a great incentive which we highlighted in our article, What ends up in your pocket.
With this recent announcement, both accountants and Portfolio Managers will be busy collaborating to determine the best course of action for each client. Every client situation is unique and having a discussion with your advisors is important, especially if you have significant unrealized capital gains.
In January 2021, we wrote an article — Capital gain inclusion rate could change quickly — that provided a good background on the history of taxation of capital gains. Below is a summary of the most recent changes pertaining to capital gains.
Capital gains inclusion rate
Currently, 50 per cent of capital gains are included in calculating a taxpayer’s income. This is referred to as the capital gains inclusion rate. The 50 per cent inclusion rate also applies to capital losses.
The 2024 budget proposes to increase the capital gains inclusion rate from 50 per cent to 66.67 per cent for corporations and trusts, and from 50 per cent to 66.67 per cent on the portion of capital gains realized in the year that exceed $250,000 for individuals, for capital gains realized on or after June 25, 2024.
The $250,000 threshold would effectively apply to capital gains realized by an individual, either directly or indirectly via a partnership or trust, net of any:
• current year capital losses;
• capital losses of other years applied to reduce current-year capital gains; and
• capital gains in respect of which the Lifetime Capital Gains Exemption (LCGE), the proposed Employee Ownership Trust Exemption, or the proposed Canadian Entrepreneurs’ Incentive is claimed.
For taxpayers claiming the employee stock option deduction, they would be provided a 33.33 per cent deduction of the taxable benefit to reflect the new capital gains inclusion rate but would be entitled to a deduction of 50 per cent of the taxable benefit up to a combined limit of $250,000 for both employee stock options and capital gains.
Net capital losses
Net capital losses of prior years would continue to be deductible against taxable capital gains in the current year by adjusting their value to reflect the inclusion rate of the capital gains being offset.
This means that a capital loss realized prior to the rate change (June 25, 2024) would fully offset an equivalent capital gain realized after the rate change. This also means that any losses realized after June 25, 2024, would be at the new inclusion rate of 66.67 per cent.
For corporate accounts that have tax years that begin before and end on or after June 25, 2024, transitional rules will apply such that two different inclusion rates would apply based on when the capital gains and losses are realized.
For capital gains and losses realized before June 25, 2024, they would be subject to the 50 per cent inclusion rate.
For capital gains and losses realized on or after June 25, 2024, the higher inclusion rate would apply on all capital gains for corporations and trusts and those exceeding the $250,000 threshold for individuals.
The annual $250,000 threshold for individuals is proposed to be fully available in 2024 and would not be prorated. It would apply only in respect of net capital gains realized on or after June 25, 2024.
Previous changes
In 2000, the inclusion rate changed twice in one year. On Feb. 28, 2000, the federal budget was announced, andthe inclusion rate was changed from 75 per cent back to 66.67 per cent. This change was effective immediately. Then, on Oct. 18, 2000, the federal government changed the inclusion rate again, from 66.67 per cent down to 50 per cent, effective immediately.
What is different about the 2024 change is that there is a two-month delay between the announcement date and the effective date of the proposed increase. Essentially, individuals, corporations, and trusts have two months to realize capital gains before the new inclusion rates begin.
Stress test the upcoming change to the inclusion rate
Capital gains apply to many types of assets. For our clients, capital gains apply primarily on real estate and investment portfolios.
Below are a few examples (one with real estate and the other with a stock portfolio) of how individual taxpayers could be impacted by the change to the inclusion rate. In the illustrations below, we will assume the taxpayer is already in the top marginal tax bracket prior to any capital property dispositions.
Unrealized gains on real estate
Let’s assume a client has owned a principal residence and a rental property, each for more than two decades. The rental property was acquired 23 years ago. The adjusted book value is $170,000. The market value of this property today is $1,400,000.
The difference between the market value and the adjusted book cost is a capital gain of $1,230,000 ($1,400,000 less $170,000). If the property was sold with the current inclusion rate of one-half, then 50 per cent of the capital gain, or $615,000 ($1,230,000 x 50 per cent), would be considered the “taxable capital gain.”
When dealing with capital gains, the word “taxable” factors in the inclusion rate. The 2024 top marginal tax rate is at 53.5 per cent (20.5 per cent B.C. plus 33.0 per cent federal). Assuming the client is already in the top marginal tax bracket, the taxpayer would have a tax liability of $329,025 ($615,000 x 53.5 per cent) if the rental property was sold.
Let’s now see what happens if the property is sold after June 25, 2024, when the inclusion rate is proposed to increase to 66.67 per cent.
The capital gain of $1,230,000 would remain the same, but there are now two calculations that need to be done.
The first one would be on the first $250,000 of capital gains and the next calculation would be on the remaining capital gain of $980,000 ($1,230,000 - $250,000). The taxable capital gain on the first $250,000 would be $125,000 ($250,000 x 50 per cent). The remaining taxable capital gain on the remaining $980,000 would be $653,366 ($980,000 x 66.67 per cent).
The taxable capital gain would change to $778,366 ($125,000 + 653,366). The taxpayer would have a tax liability of $416,425.81 ($778,366 x 53.5 per cent).
Under the proposed change, the individual’s tax liability will increase by $87,400.81 ($416,425.81 -$329,025).
Unrealized gains on non-registered investment portfolio
A client has owned a basket of quality blue chip equity stocks for close to 30 years. The client has not had the need to sell the holdings and has been mainly living off the dividends from the investment portfolio. The unrealized gains in the portfolio have grown over the decades due to a buy and hold approach and not wanting to trigger a tax liability.
In some cases, triggering a large capital gain could result in losing old age security benefits or losing subsidies for clients who are in an income tested assisted living facility as it could increase a client’s taxable income.
When looking at this client’s portfolio, the unrealized gain was $920,000. Unrealized gain means the difference between the current market value and the adjusted book cost of investments not yet sold.
If the investment portfolio was sold, at the (50 per cent inclusion rate (current rate), the taxable capital gain would be $460,000 ($920,000 x 50 per cent).
Assuming the top marginal tax bracket of 53.5 per cent, the tax liability would be $246,100 ($460,000 x 53.5 per cent).
Let’s now see what happens if the client waits until after June 25, 2024, to realize the capital gains.
Again, we need to do two calculations. The first one would be on the first $250,000 of capital gains and the next calculation would be on the remaining capital gain of $670,000 ($920,000 - $250,000). The taxable capital gain on the first $250,000 would be $125,000 ($250,000 x 50 per cent).
The remaining taxable capital gain on the remaining $670,000 would be $446,689 ($670,000 x 66.67 per cent). The taxable capital gain would change to $571,689 ($125,000 + $446,689). The taxpayer would have a tax liability of $305,853.62 ($571,689 x 53.5 per cent).
Under the proposed change, the individual’s tax liability will increase by $59,753.62 ($305,853.62 – $246,100).
More tax dollars
The average individual, without a trust or corporation, may feel that these changes do not impact them as they don’t plan to realize more than $250,000 in capital gains in a single year. Many of our clients have substantial unrealized capital gains within their non-registered investment portfolios that well exceed this amount.
An item to remind clients is that in the year a person passes away there can be some harsh tax liabilities if they do not have a spouse to have deferral on the first passing. For widowed, or single individuals, they will have to include 100 per cent of the value of their RRSP or RRIF account into income which already pushes estate taxes to a high level.
Compounding this, is that 66.67 per cent of all unrealized gains above $250,000 will also be taxed. This change in the inclusion rate will absolutely increase estate taxes for many people.
With the end goal of the government to collect more tax dollars, changing the inclusion rate on capital gains accomplishes that. With the government giving a two-month delay to implementation, they are effectively pushing clients to realize gains earlier than they likely would have — this in turn enables the government to collect more tax dollars sooner.
This will lead to a boost in tax revenue for 2024 as people rush to sell properties and investments before the new inclusion rate takes effect. In our opinion, this was the intention so that the government could quickly get more tax dollars to pay for the other spending programs they have announced.
The end result: Less money in your pocket!
The future
The deficit numbers in the U.S. and Canada look scary. Many of the high-net-worth clients feel that it is their obligation to pay their fair share in taxes. What annoys them the most is when the government foolishly spends money and our debt levels rise.
When interest rates were low, the common discussion was that the government went on a spending spree without any thought of what would happen when interest rates rise. If spending doesn’t come under control, our prediction is that they will be forced to raise further tax revenues.
We feel that nothing is off the table, including that the government eliminating the tax preferential treatment on capital gains, including on our principal residences.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250.389.2138, email [email protected], or visit greenardgroup.com.
