Chapter 7

Capital Gains: Personal

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Overview of the Taxation of Capital Gains

• History

Time Period Inclusion Rate

Prior to 1972 Not taxable

1972 to 1987 50%

1988 and 1989 66 ⅔%

1990 to February 27, 2000 75%

February 28 to October 17, 2000 66 ⅔%

After October 17, 2000 50%

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Capital Property

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Terminology

Accounting terminology

Income Tax terminology

Selling Price $xx Proceeds of Disposition (P of D) Sec. 54

Cost $xx Adjusted Cost Base (ACB) Sec. 54

Selling costs xx (xx) Expenses of disposition Ssec. 40(1)

Profit (Loss) $xx Gain (loss)

(xx) Exemption or reserve, if any Sec. 40

$xx Capital gain (CG) or Capital loss (CL)

Sec. 39

$xx Taxable capital gain (TCG) or Allowable capital loss (ACL)

Sec. 38

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Terminology

• Dispositions– Any transaction entitling a taxpayer to proceeds of

disposition

• Deemed dispositions:– On change in use of property

– On death of a taxpayer

– By way of gift during the lifetime of a taxpayer

– When taxpayer ceases to be a resident of Canada

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Terminology

100% 50%

Capital gain (CG) Taxable capital gain (TCG)

Capital loss (CL) Allowable capital loss (ACL)

Business investment loss (BIL)Allowable business investment loss

(ABIL)

Capital gains exemption (CGE) Capital gains deduction (CGD)

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General Rules

Capital Gain/

(Capital loss)= Proceeds of

Disposition- ACB +

Expenses ofDisposition

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Specific Provisions

• Personal-Use Property (PUP)– Property used primarily for personal use or enjoyment

– Gains: Subject to tax

– Losses: May not be deducted

– Taxpayer’s cost deemed to be greater of:i. ACB of the property

ii. $1,000

– Taxpayer’s proceeds deemed to be greater of:i. Actual proceeds

ii. $1,000

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Specific Provisions

• Listed Personal Property (LPP)– Special subset of PUP

– Capital losses can be used but only to extent of LPP gains

– Carryover (three years back and seven years forward) only against LPP gains (applied under Div. B not Div. C)

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Specific Provisions

• Listed Personal Property (LPP)– LPP includes PUP that is a (sec. 54):

• Print, etching, drawing, painting, sculpture, or other similar work of art;

• Jewellery;

• Rare folio, rare manuscript, or rare book;

• Stamp; or

• Coin.

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Principal Residence Exemption

• Gain on principal residences can be exempted– Taxpayer must designate home as “principal residence”

for specific years

– Any residence may be a principal residence as long as taxpayer ordinarily inhabits the home, even for a short time

– Only one residence can be designated for a given year

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Principal Residence Exemption

Steps to follow:1. Calculate the capital gain per year for each principal

residence.

2. Determine if any of the years of ownership have been allocated to previous principal residences.

3. Allocate the years available to each residence to optimize the exemption.

4. Determine exemption using the simplified formula:

1 + # of years designated# of years owned × gain

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Change in Use of a Principal Residence

• Change from personal use to income-producing or from income-producing to personal use– May designate home as principal residence for up to four years

• Modified principal residence exemption formula:

1 + # of years designated after the later ofDec. 31, 1971 and the date it was last acquired

# of years during which the property was ownedafter the later of Dec. 31, 1971 and the date on which

it was last acquired

× gain

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Change in Use of a Principal Residence

• Income Tax Folio S1-F3-C2 — Principal residence

• Section 54.1 – Extended designation

• Principal Residence Exemption – Transfer between spouses– Single-ownership situations– Joint ownership situations

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Capital Losses

• Allowable capital loss only deductible against taxable capital gain, and taxable net gains from listed personal property, to the extent needed to bring those gains to zero

• Carryovers:– Carried back three years – Carried forward indefinitely

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Pooling of Identical Assets

• “Floating weighted-average method” for identical assets

• Certain securities are exempt from cost-average rule by deeming such securities not to be identical to any other securities acquired by the taxpayer and include:– Securities acquired under an employee option agreement

– Employer shares received by an employee as part of a lump-sum payment on withdrawing from DPSP

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Disposition of Shares Acquired under a Stock Option

• Disposition of newly acquired securities– Taxpayer is allowed to designate the particular security

being disposed of if:• Security is acquired under an employee stock option agreement

• Disposition occurs no later than 30 days after the taxpayer acquires the particular security

• No other acquisitions or dispositions of identical securities in the intervening period

• Taxpayer makes the designation in the tax return that is filed for the year in which the designation occurs

• Taxpayer does not designate the particular security in connection with the disposition of any other security

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Disposition of Shares Acquired Under a Stock Option

• ACB of shares acquired under a stock option– Employment benefit that taxpayer is deemed to

have received is added to the ACB– Employment benefit included in ACB from the

time of acquisition until taxpayer disposes of the security

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Cost of Certain Properties

• General considerations

• Dividends in kind and lottery prizes

• Stock dividends

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Superficial Losses

• Taxpayer denied loss at the time of disposition but can add the superficial loss to the ACB of substituted property

• Superficial loss occurs when:– Taxpayer or “affiliated person” disposes of property;

– Taxpayer or affiliated person acquires or reacquires the same or identical property during the period beginning 30 days before the disposition and ending 30 days after the disposition; and

– Taxpayer or affiliated person, at the end of the period above, still owns at least some of the property.

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Options (Exhibit 7-1)

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Convertible Properties

• Conversion is deemed not to have been a disposition of property– ACB of shares = ACB of convertible property– No cash consideration can be received

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Capital Gains Deferral

• Individuals can defer recognition of capital on certain small business investments– Must use proceeds from the sale of small business

investment to acquire other small business investments

– Deferred gain reduces ACB of new investment

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Non-Arm’s Length Transfers

• Non-arm’s length rules prevent tax avoidance in certain transactions

• Who does not deal at arm’s length?– Related persons

– A beneficiary, or anyone not dealing at arm’s length with the beneficiary, and the inter vivos or testamentary trust

– It is a question of fact

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Non-Arm’s Length Transactions Rules(Exhibit 7-2)

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Attribution Rules

• Capital gains on spousal transfers or loans– Attributed back to the transferor spouse or

common-law partner

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Transfers or Loans of Property to Spouse/Common-law Partner

(A) Proceeds and Cost on Transfer

TransactionTransferor’s

proceeds Transferee’s cost

(1) Gift • No election out of interspousal rollover

Transferor’s ACB/UCC

Transferor’s ACB/UCC

• Elect not to have rollover FMV[par. 69(1)(b)]

FMV[par. 69(1)(c)]

(2) Sale • No election out of interspousal rollover

Transferor’s ACB/UCC

Transferor’s ACB/UCC

• Elect not to have rollover Greater of:• Actual proceeds• FMV [ssec. 69(1)]

Lesser of:• Actual cost• FMV[ssec. 69(1)]

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Transfers or Loans of Property to Spouse/Common-Law Partner

(B) Attribution of Income and Capital Gains

Business Income Property Income Capital Gains

On transferred or loaned property and substitute property

n/aAttributed

[ssec. 74.1(1)]Attributed[ssec. 74.2]

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Avoiding Income Attribution on Transferred Property

Subsection 74.5(1) – FMV Transfer1. FMV consideration must be received by the vendor.

2. If part of the consideration is debt, then interest must be charged at the prescribed rate and always paid by January 30 of the following year.

3. If it is a transfer to a spouse/common-law partner, then they must elect out of the interspousal transfer.

Subsection 74.5(3) – Relationship Breakdown1. The spouses/common-law partners are living separate and apart

by reason of the breakdown of their relationship.

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Transfers or Loans of Property to Minors and Other Non-Arm’s Length Individuals

(A) Proceeds and Cost on Transfer

Transferor’s proceeds Transferee’s Cost

(1) Gift FMV[par. 69(1)(b)]

FMV[par. 69(1)(c)]

(2) Sale Greater of:• Actual proceeds• FMV [ssec. 69(1)]

Lesser of:• Actual proceeds• FMV [ssec. 69(1)]

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(B) Attribution of Income and Capital Gains

Business Income Property Income

Capital Gains

Minors who are not at arm’s length or who are nieces or nephews

n/aAttributed

[ssec. 74.1(2)]n/a

Other non-arm’s length individuals not subject to section 74.1

n/aAttributed

[ssec. 56(4.1)]n/a

Note: Only on loaned property if one of the main reasons was to reduce or avoid tax.

Transfers or Loans of Property to Minors and Other Non-Arm’s Length Individuals

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Death of a Taxpayer

• Deemed disposition on death– If beneficiary is spouse, deemed disposed at

ACB.– If beneficiary is someone other than spouse,

deemed disposed at FMV.

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Leaving Canada

• When taxpayer ceases to be resident of Canada, all capital property deemed to be disposed at FMV except for:– Property that is

• Canadian property that is not very movable

• Canadian property that is not very liquid or marketable

– Property of a business carried on by the individual in Canada.

– The right to receive certain payments such as pension payments and other retirement benefits.

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Entering Canada

• Deemed to acquire all of property at FMV at the time except for:– Taxable Canadian property– Inventory or eligible capital property of a

business carried on in Canada

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Computation Rules – Section 3ITA Par. Type of Income

3(a) Worldwide income from non-capital sources including (positive amounts):• Office or employment• Business• Property• Other non-capital sources

Plus

3(b) Taxable capital gains and allowable capital losses

Less

3(c) General deductions not attributable to any source• Moving expenses, alimony, RRSPs, etc.

Less

3(d) Negative amounts or losses from non-capital sources including:• Office, employment, business, and property, and• ABILS

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Allowable Business Investment Losses (ABILs)

“Business Investment Loss” includes capital losses

arising from the disposition of shares and debts of a

small business corporation (SBD).

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ABILs• Business investment losses (BILs) are a subset of

capital losses• ABILs determined using the same inclusion rates

as allowable capital losses• Portion of BIL is disallowed if capital gains

deduction previously claimed – calculated as lesser of:

(a) BIL for the year $xxx

(b) Cumulative capital gains deduction claimed in previous years x a factor

$xxx

Minus: cumulative disallowed portion of BILs in preceding years

(xxx)

$xxx37

Treatment of Business Investment Loss

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