Capital Gains Tax on a Sale of a Property

Can you get away with capital gains tax?

There has been a trend with property owners selling their rental units due to the many changes we face today. Many sellers are wondering if there is a way to get around capital gains tax.

We invited a CPA who often works with the Chamberlain Real Estate Group, Robert Neufeld, who has been in the accounting industry for about six years now. He shares how capital gains work when selling a rental property and the variables associated with it.

How Capital Gains Work

In a simple scenario, capital gain occurs when you sell an investment property like a rental home. For example, you invested $400,000 to buy a house and you decided to sell it after ten years for $500,000. In this case, you earned $100,000, which is considered as a capital gain.

Now, there is a capital gain, and there is a taxable capital gain. A taxable capital gain is 50% of the total gain. In the earlier example, 50% of the $100,000 profit is taxable, and 50% is not taxable. You will get your $50,000 tax-free!

The taxable half will be added to your personal tax return. The tax due on that $50,000 will depend on whatever tax bracket you are in. For example, if you're in the 30% tax bracket, you need to pay 30% of $50,000 for your capital gain.

Getting Around with Capital Gains Tax

We have helped many clients sell their rental properties in the past, and we encountered people who asked if they could avoid paying capital gains tax.

As per Robert Neufeld, the only way you can avoid paying capital gains tax is if you don’t have a rental property or if you don’t sell one! Because in reality, there is no way to avoid it if you are selling a rental property.

But there are some things that you can do to reduce your tax bill. If you had two rental properties, one was doing well, so you sold it with $100,000 gain, and the other one was sold at $100,000 loss, the capital gain and the capital loss could very well cancel each other.

If you have some stocks and you have a loss, you can also use them to offset your capital gain on the sale of your rental property. For instance, you had a loss from some stocks last year, but you didn't have a capital gain last year to offset them. Those losses will stay in a notional account, and you can carry that forward to this year when you sell at a key.

The same thing works with a property. If you were to sell it at a loss this year and sell again next year, you could carry that loss forward to the following year. You can carry those losses indefinitely and let them sit on the books to be used in the future. The good news is that you don’t need to watch this proactively as capital loss is tracked by CRA and by your tax preparer if you are using the same software year after year.

Capital Gains on Personal Home

If you are planning to sell your personal home and wonder if capital gains come into play with it, the simple answer is no.

If you bought a house for $400,000 and sold it at $500,000 and used it as a principal residence, you still have a gain. You need to report it on your tax return, but it is exempted from tax as it falls under the principal residence exemption.

If the property had a change in use at any time, like from being a principal residence to rental property, capital gains might apply. Let’s say you bought the house in 2014 and lived there for a while, and you turned it into a rental home starting in 2018 until today. Or you can also have the opposite scenario, from a rental property to your principal residence.

In those cases, there are elections that you need to file at the time of the change in use. In doing so, it is essential to note what the fair market value was at that time. But the tax on the property will depend on a lot of variables. It is best to talk to your accountant to help you understand your situation and do the best thing to move forward.

Capital Cost Allowance

When you have a rental property, you have the option of taking depreciation expense each year that you own the property. What it does is reduce your taxes on the rental income that you earn throughout the ownership of that property.

Keep in mind that doing this also depreciates the value of that property for tax purposes. In our example, where you bought a house at $400,000, if you take this depreciation expense, you may depreciate the value of that house for tax purposes down to $350,000 over the life of ownership.

When you sold at $500,000 and took an expense of $50,000 over the life of ownership, it is called recapture because you take an expense to depreciate an asset that appreciates. So, essentially, you have to repay all the taxes you took as a write-off over the asset’s life.

You may want to take that expense when you expect to have a property to depreciate or when you prefer to pay the full tax bill when you sell because then you have the cash from the sale. There are different thoughts on whether this should be done or not, but it certainly can make your tax bill a lot bigger when you sell if you take that expense.

Terminal Loss

When you sell a property, you can have a terminal loss/or a capital loss. Terminal loss is associated with the property’s depreciable portion, which essentially means the building portion of the property.

The capital loss is generally attributed to the land portion of the sale. If you buy an apartment-style condo unit for $100,000 and sell it at $300,000, you will have a terminal loss. If you have a house with land and a building component, you will most likely have a terminal loss and a capital loss.

Taking note of the value and attributes of the property when you bought it and when you sold it is helpful. Terminal losses are essentially good because they can be used against other income, but capital losses can only be used to offset capital gains.

You might have a condo and moved into a house, but you still kept your condo as a rental because its value dropped. Then you finally made up your mind that you don’t want to be a landlord anymore and the market is a little bit better. You might still sell at a loss, but it is pretty acceptable this time.

In this situation, you might be able to recapture some of the terminal loss that you have against your employment income. Talk to your accountant about this because you might be able to get a tax refund in the process!

If you have any questions about capital gains or any accounting matters, you can reach out to Robert Neufeld through their website, www.hamroes.com. And as always, you can email us at info@chamberlaingroup.ca for any of your real estate needs because we are here to help you move up to your dream home!