With barely a month to go before the June 25, 2024, deadline to realize capital gains at the lower 50 per cent inclusion rate before that rate goes up to two-thirds, investors are asking if they should take action to crystallize gains before the deadline.
Let’s look at four common scenarios we’ve been asked about since the federal budget announcement on April 16. But before doing so, let’s recap the capital gains tax rules and what’s changing.
Under the current rules, if you dispose of capital property (other than your principal residence) for a profit, only 50 per cent of the capital gain is taxable. The budget proposed to increase the inclusion rate to two-thirds for capital gains realized on or after June 25, 2024. Individuals will still be entitled to the 50 per cent inclusion rate on the first $250,000 of capital gains annually, but corporations and trusts will not be.
The actual increase in the tax rate on capital gains of more than $250,000 is approximately nine percentage points, depending on your province of residence. For example, a British Columbia investor who is in the top marginal tax bracket currently pays capital gains tax of 26.75 per cent on any capital gains realized before June 25. The same rate will apply to the first $250,000 in gains on or after June 25, and in each future year. But come June 25 and the new two-thirds inclusion rate, that B.C. investor is now looking at a capital gains tax rate of 35.67 per cent on gains over $250,000, an increase of 8.92 percentage points.
The investor
For an investor with significant accrued gains in their portfolio, crystallizing a gain at the current 50 per cent inclusion rate is as easy as selling your position on the open market and immediately buying it back. Unlike loss crystallization planning, usually done at year-end to realize capital losses that can then be applied against any capital gains, there’s no equivalent superficial gain rule, meaning you don’t need to wait 30 days to buy back the stock on which you crystallized your gain. For stocks with losses, however, the superficial loss rule will deny a loss if the stock is repurchased within 30 days.
If you do plan to crystallize, be mindful of the June 25 deadline. To ensure you get the 50 per cent inclusion rate, your trade needs to be settled before the deadline, meaning by June 24. With both the Canadian and United States markets moving from a T+2 to a T+1 settlement period, starting on May 27 in Canada and May 28 in the U.S., your last trading date will be Friday, June 21, for settlement the next business day, being Monday, June 24.
Of course, whether it makes sense to crystallize and essentially prepay the tax in the 2024 calendar year (due on April 30, 2025), versus paying the tax at some point in the future will depend on your expected rate of return and time horizon.
For example, if the tax you didn’t pay for 2024 was invested at a six per cent rate of return, compounded annually, it would take about eight years of tax-deferred growth, after tax, to beat the tax savings attributable to the lower inclusion rate.
Investors who are considering a significant capital gains crystallization before June 25 should ask their tax adviser to estimate their 2024 Alternative Minimum Tax (AMT) which, starting this year, includes 100 per cent of all capital gains in the income calculation. It may be possible to recover the AMT in the next seven years, depending on your personal situation.
The cottage owner
Consider Debbie, an Ontario cottage owner who inherited her parents’ cottage two decades ago when its fair market value was $400,000. After investing $350,000 in improvements over the years, Debbie’s adjusted cost base is $750,000 while the fair market value today is $2 million. That’s an accrued gain of $1.25 million and, potentially, an extra $90,000 of capital gains tax (being the tax on the excess gain above $250,000).
Debbie doesn’t plan on selling the property before June 25, but if she did want to crystallize the gain before the deadline to pay tax at the lower rate, she could transfer the property to her children, either directly or via a family trust, which would trigger the gain. But then Debbie would have to come up with the cash to pay the $335,000 of capital gains tax by April 30, 2025. And, does she really want to give the cottage to the kids today?
Many clients balk at the crystallization option when faced with the reality of such a steep tax bill.
The elderly investor
An elderly investor reached out to me to ask what he should do, given that he was now in his early nineties and was sitting on considerable gains on his various assets and real estate.
I jokingly asked him how long he was planning to live, to which he responded that he would be happy if he was around for another two years. I chuckled, but then suggested he sit down with his accountant or tax adviser and seriously consider realizing those gains by June 25. By doing so, less of his estate will end up with the government, and more will be available to his beneficiaries, including, potentially, charities.
Professional corporations
Finally, one question that has come up many times since the budget is whether it still makes sense for professionals, such as doctors or lawyers, to incorporate their professional practice. Traditionally, the answer depended on whether the professional could take advantage of the corporate small business tax rate and enjoy a tax deferral of up to 43 per cent, depending on the province.
But given that the capital gains inclusion rate will be rising to two-thirds for corporations as of June 25 from the first dollar of corporately realized capital gains, there’s now a material disadvantage of earning up to $250,000 in gains in a corporation each year versus earning those gains personally. The additional tax cost ranges from 10 to 15 percentage points of tax, on a fully integrated basis.
The answer, therefore, will depend on many factors, including the size of the deferral advantage, the amount of capital gains to be realized annually both inside and outside of the professional corporation, the rate of return and the time horizon.