Crystallization of Capital Gains: How to Lessen the Blow from Higher Capital Gains Taxes.

Capital gains taxes apply when you make profit on the sale of an asset, such as real estate which is not your principal residence, investments such as shares or funds, or shares of an operating business corporation.

Recently, the Canadian federal government announced changes to capital gains rules, effective from June 25, 2024. Under the new regulations, individuals with significant capital gains per year will face an additional tax rate. For investors and shareholders, this means that sales of their assets will be subject to the revised rates:

The proposed transitional rules will ensure that the $250,000 threshold is not prorated in 2024 and will apply only against capital gains realized on or after June 25, 2024.

How to beat the higher capital gain tax rate:

• Selling before June 25th. We discussed the sale in our blog titled Navigating the New Capital Gains Tax: What Canadians Need to Know or
• Crystallization of capital gains which is the focus of this blog.

Crystallization of Capital Gains

Many taxpayers are currently contemplating whether to realize their accrued capital gains before June 25 to capitalize on the 50% inclusion rate before it expires. "Crystallization" refers to the act of recognizing an accrued gain while still maintaining ownership of the underlying asset. This process involves selling an asset with the primary aim of triggering the capital gain, intending to repurchase the same investment afterward, effectively "crystallizing" the gain at a specific point in time while retaining the investment. Subsequently, this profit becomes subject to taxes. The inclusion rate determines the percentage of that profit subjected to taxation, with the taxed amount being determined by your marginal tax rate.

Crystallization Methods

To crystallize the accrued gain on an asset, you must execute a taxable transfer of the asset at its fair market value while still maintaining control over it. This can be achieved by transferring the asset to a holding company, a personal trust, or a spouse/common-law partner.

1. Transfer to a holding company

Transfers of assets to a corporation typically occur at fair market value for income tax purposes, unless you and the corporation file an election for the transfer to be at a lower amount. However, before proceeding with such a transfer, it's essential to consider the implications of the corporate attribution rules. These rules may necessitate including a benefit in your income based on the value of the transferred asset and the prescribed interest rate at the time.

Exercise caution if the asset with the accrued gain is expected to generate additional gains after its transfer to a corporation. Gains accrued post-transfer will eventually be subject to taxation within the corporation. The combined corporate and personal tax payable on such gains will likely exceed the tax that would have been payable had you realized them personally

2. Transfer to a Trust

Transfers of assets to a trust typically occur at fair market value for income tax purposes. However, in certain cases, the transfer may be deemed to occur at cost, though there might be an option to file an election for the transfer to be at fair market value.

Before proceeding with such a transfer, it's essential to consider the impact of the income attribution rules on income generated by the asset after the transfer date, as well as on gains realized upon the disposition of the asset post-transfer. These rules could result in such income and gains being taxed in the hands of individuals other than the intended beneficiary allocated by the trust.

Exercise caution if the asset with the accrued gain is expected to generate additional gains after being transferred to a trust. Gains accrued post-transfer will eventually be subject to taxation within the trust, and it's important to note that the inclusion rate for trusts is 66.67%, even for capital gains less than $250,000.

3. Transfer to a Spouse/Partner

Transfers of assets between spouses are automatically deemed to occur at cost for income tax purposes. Therefore, to crystallize an accrued gain, you and your spouse must file an election for the transfer to take place at fair market value.

Before proceeding with such a transfer, it's important to consider the impact of the income attribution rules on income generated by the asset after the transfer date, as well as on gains realized upon the disposition of the asset post-transfer. These rules could result in any such income or gains being attributed back to the transferring spouse.

Other taxes

Before transferring assets to crystallize accrued gains, you should also consider whether any other taxes will be payable as a result of the transfer. For example, transfers of real estate could attract land transfer taxes.

Tax Implications

The increase in the capital gains inclusion rate will change the effective rate of tax on the capital gains realized by the taxpayers on or after June 25, 2024. The effective change in tax rates due to these proposed changes is summarized below:

Individuals who do not expect to earn capital gains exceeding the $250,000 threshold may want to consider holding their investments directly rather than a corporation as corporations will not have a minimum threshold under the proposed changes.

For further information please contact Taxtron Support at 416-491-0333 or visit www.taxtron.ca (opens in a new tab)