The federal government has announced proposed changes to capital gains tax rules, citing concerns that wealthier Canadians tend to derive a larger portion of their income from capital gains, so tend to disproportionately benefit from the capital gains tax advantage. In 2021, the top 1% earned 10.4% of all income in Canada, but this figure rose to 13.4% when factoring in capital gains. This trend is particularly significant when considering younger Canadians, as only about 5% of Canadians under 30 reported any capital gains in 2021.
It proposes in Budget 2024 to amend the Income Tax Act, effective June 25, 2024, by increasing the inclusion rate on capital gains realized annually above $250,000 by individuals and on all capital gains realized by corporations and trusts from one-half to two-thirds. Capital gains for individuals up to $250,000 will remain unchanged at one-half. Business owners can access this exemption as individuals. Only 0.13% of Canadians with an average income of $1.4 million are expected to pay more personal income tax as a result of this change.
The exemption for capital gains from the sale of a principal residence will continue. The lifetime capital gains exemption, which currently allows tax-free exemption up to $1,016,836 on the sale of small business shares and farming and fishing property, will be raised to $1.25 million as of June 25, 2024. This amount will be indexed to inflation in future. As of January 1, 2023, capital gains from property flipping, or residences being sold within a year, are being treated as business income, with certain exceptions.
To ensure entrepreneurship is not discouraged, the government is also proposing the Canadian Entrepreneurs’ Incentive, which will reduce the inclusion rate to 33.3% on a lifetime maximum of $2 million in eligible capital gains. Combined with the lifetime capital gains exemption, this makes a total of at least $3.25 million if an entrepreneur sells all or part of a business. For some real estate investors, this could prove a valuable exemption.
However, for some individuals with second properties, including cottages, this may pose a concern. Investors need to be aware of the impacts that triggering this higher inclusion rate may have on the potential profitability of an investment.
In the short term, however, this may potentially create greater opportunities for buyers, as many individuals may choose to sell quickly before the change takes place, to avoid the extra tax.