Capital gains can affect anyone when liquidating an asset of substantial value. The implications are much higher when we are talking about real estate. Even a modest percentage appreciation can be rather burdensome when the tax bill comes due.
If you are selling, or thinking about selling, an investment property or second home, you likely have questions. How much will you owe, and is there any way to get around the inevitable? In this post, we’ll talk all about capital gains and what they mean for your real estate transaction.
Do you want customized guidance to help make your real estate investments a success? Learn more about how our team works with investors in Guelph and the Tri-Cities.
What Are Capital Gains?
Think of capital gains as the government’s share of your wealth. Whenever anyone anywhere in the country earns money, the government always wants its share. This applies when it comes to your annual income, and it’s true when you have any asset that increases in value.
It could be stocks or a business you own. Alternatively, it could be any house, condo, vacation property, or rental unit you own in addition to your primary residence.
Fortunately, your primary residence is exempt. If you bought your house 10 years ago and it has increased in value by $200,000, the gain is all yours, at least for now. If it’s an additional property over and above the home you live in, capital gains apply.
Unlike with your income tax, however, you don’t need to pay capital gains on a regular basis. If you buy an income property or second home and hold it, you have what’s called “unrealized” capital gains. Your asset has increased in value, but there’s nothing to pay unless you cash out.
A smart real estate investment begins with the successful purchase of the right property. The posts below will help you cover all of the bases:
- How to Choose a Real Estate Agent When Buying a House
- Title Insurance in Canada: What It Is, Why It Matters & How We’ve Got You Covered
- How to Get a Mortgage
How Much Are Capital Gains?
We suppose Canadians could breathe a collective sigh of relief. A few years ago, there were talks about raising the rate of capital gains to 67% of any appreciation.
After much heated debate and voter outrage, our elected officials decided to let it remain at 50%. (There were some additional rumours that the principal residence exemption was about to be scrapped at the same time. Thankfully, that has also not happened.)
Here’s an example of how capital gains work:
Imagine you’re the parent whose child is about to head off to college or university. Instead of spending thousands of dollars on residence, you buy a student rental.
Now, your child has a place to stay and you have a valuable asset that you can later resell and perhaps earn a profit. In the meantime, you can rent out the other rooms to help cover the monthly carrying costs. Anyway you look at it, it’s a better investment than paying for residence.
However, the tax implications begin once you start preparing to sell your investment.
If you paid $500,000 for the home then sell it four years later for $600,000, you have earned $100,000. 50% of this is taxable, which means adding an additional $50,000 to your income for the year. A large amount may also put you into the next tax bracket, if not higher.
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Is There Any Way to Save on Capital Gains?
As real estate agents, taxes are not our field of expertise. Nevertheless, a good tax lawyer or financial advisor might be able to help you offset capital gains to a certain extent.
One example is if you sell your student rental to your child, who will then use it as their primary residence. If you provide seller financing and take payment for the property in installments, you could potentially spread capital gains out over a period of four years.
Instead of claiming $50,000 all at once, you add $12,500 to your income each tax period. This can reduce the burden significantly, especially if it keeps you in a lower tax bracket.
Do you want to make successful real estate investments in spite of a shifting market? Start by studying the valuable resources below:
- A Complete Guide to Real Estate Investing in Guelph
- Could Buying During A Recession Be A Genius Investment?
- Negotiating With Tenants as a Guelph Real Estate Investor
Talk to Your Tax Advisor Before Proceeding
Seller financing could be an excellent deferral strategy, but it doesn’t always apply. It may also be a financial risk you don’t wish to take. Fortunately, other paths may also be available to you. An experienced financial or tax advisor may advise any of the following:
- Be sure that you maximize all contribution room in your RRSPs.
- Calculate the cost of all capital expenditures, like installing new windows or building an additional bathroom. That said, it’s important to discern between legitimate capital expenditures and regular maintenance and minor touch-ups. Not every expense can be claimed.
- If you own multiple properties, try to sell them over the span of several years rather than all at once. That way, you’re not charged at the highest tax bracket.
- Remember all of the closing costs that you may have lamented at the time of purchase? You may be able to claim them now to reduce the profit from your sale, which means a lower tax amount.
- If you have multiple assets that you are liquidating in the same year, you can use any capital losses to help offset capital gains. (However, you cannot claim a loss on your taxes against your current income.)
Ultimately, there is no escaping capital gains altogether. Just like any other tax, they are inevitable. Nevertheless, expert financial advice can help you defer and possibly even reduce the overall amount owing. It never hurts to investigate your options!
Do you have questions about buying or selling an investment property or second home? Our top Guelph real estate agents are here to guide you every step of the way. Reach out to info@gowylde.ca or call 519-826-7109 for more information.
