The federal budget’s proposed increase to the capital-gains inclusion rate, effective June 25, raises the question of whether investors should sell taxable assets before the new rate kicks in. Currently, 50 per cent of capital gains are included in taxable income. Under the budget proposal, that inclusion rate would increase to 66.7 per cent in some cases.
While it may make sense for some people to sell their taxable assets before June 25, the answer is far from simple.
What’s changed?
By increasing the proportion of a realized capital gain that is included in taxable income, the 2024 budget proposal would result in the top capital-gains tax rate for individuals in Ontario increasing to 35.69 per cent from 26.77 per cent.
While the capital-gains inclusion rate (and by extension the tax rate on capital gains) is set to increase, the first $250,000 of gains earned by an individual will be taxed based on the current inclusion rate of 50 per cent. Corporations – which are where many small business owners and professionals do their investing – are getting hit harder. They will pay tax based on the new higher inclusion rate on their first dollar of capital gains.
Corporate taxation in Canada is complex, but by my calculations a capital gain realized in a corporation in Ontario will ultimately leave a shareholder in that province taxed at a total rate of 38.62 per cent on a realized capital gain, compared with the current 28.97 per cent.
What should people do?
The big financial-planning question is whether people should sell taxable assets before June 25 while they still have access to the 50-per-cent inclusion rate, with no cap.
Let’s think about an example where an individual at the top marginal tax rate in Ontario has a $1,000,000 capital gain. That asset sale would result in a tax bill of about $268,000 on the capital gain prior to June 25; after that date the tax would be about $335,000.
That’s a big difference, but it’s still not obvious that everyone should be selling their taxable assets before June 25. Selling now, while resulting in a lower tax bill today, also means you pay that tax bill soon, as opposed to some point in the future.
A longer-term view
Continuing with this example (and assuming it’s a portfolio of equities), realizing the gain before June 25 is more advantageous. But over longer time horizons, by deferring the tax – even with the higher future inclusion rate – the investor comes out ahead.
For smaller capital gains, many individuals will be unaffected by the changes owing to the $250,000 limit, but those selling or otherwise disposing of larger assets (such as cottages, rental properties and some investment portfolios) will likely be affected.
A potential tax trap
An important consideration before selling any assets is the Alternative Minimum Tax (AMT). The Canadian tax system runs two parallel calculations. One is the regular taxation framework that most people are familiar with. The other is the AMT, which is applied by the CRA to ensure that those on high incomes pay a minimum amount of tax no matter what deductions or credits they have. If the tax owing calculated under the AMT is higher than that which would be owing under the regular system, you pay the AMT.
The important point to take away is that at the 50-per-cent inclusion rate, large capital gains will often trigger AMT, particularly for people with lower sources of other income. The inclusion rate is 100 per cent for the 2024 AMT calculation.
Some of that AMT may be recoverable as the AMT can be carried forward for up to seven years and used to offset future taxes, but a taxpayer with no other sources of income may not be able to recover any of it. By effectively increasing the tax rate on the initial capital gain, this can change the math on whether it makes sense to realize capital gains now or to defer them.
Takeaways
The proposed changes to the capital-gains inclusion rate will not affect individual investors with capital gains under $250,000. All others need to take careful stock of their specific situation.
In some cases, it may be better to sell assets before June 25, but for long-term investors, unless they were planning on liquidating for some other reason, deferring unrealized capital gains often still makes sense. For large capital gains and low sources of other income, AMT will be a major consideration in this decision.
Benjamin Felix is a portfolio manager and head of research at PWL Capital. He co-hosts the Rational Reminder podcast and has a YouTube channel. He is a CFP® professional and a CFA® charterholder.
