How to handle the two capital gains inclusion rates planned for this year

National Post

2024-06-13



One area that has sparked a lot of questions since budget day about the proposed increase in the capital gains inclusion rate is how capital losses will be treated, particularly this year when two separate rates will apply.

A capital loss typically occurs when you sell an investment for less than you paid for it. For example, if you bought shares for $10,000 and sold them for only $4,000, you would have a capital loss of $6,000. This capital loss can only be applied against other capital gains.

First, you must apply them against other capital gains in the tax year in which the capital loss was realized. Once you’ve exhausted all gains in that current year, you can choose to carry any net capital loss back and apply it against any taxable capital gains in any of the previous three years. Alternatively, they can be carried forward indefinitely and used to reduce taxable capital gains in any future year.

But how will the loss carryback and carryforward rules apply with the change in inclusion rates? What if a loss is realized when the inclusion rate was 50 per cent, but the gain to which you want to apply that loss is at the new two-thirds inclusion rate? And how do taxpayers deal with the two separate inclusion rates in 2024? The draft legislation and backgrounder released this week help answer these questions.

Under the proposed legislation passed by the House of Commons on Tuesday, net capital losses realized in other tax years are deductible against current-year taxable capital gains by adjusting their value to reflect the inclusion rate of the capital gains being offset. This means that a capital loss that was realized when one inclusion rate was applied can still fully offset an equivalent capital gain realized in a year during which another inclusion rate was applied.

Continuing our example above, let’s say the taxpayer incurred that $6,000 capital loss in 1998, when the inclusion rate was 75 per cent. This resulted in a net capital loss of $4,500. Now, let’s assume the taxpayer realized a capital gain of $6,000 in 2023, when the inclusion rate was 50 per cent, resulting in a taxable capital gain of $3,000.

If the taxpayer claimed the $4,500 net capital loss from 1998 as a deduction in computing their taxable income in 2023, the taxpayer would be entitled to a deduction of only $3,000 because the net capital loss from 1998 needs to be adjusted to reflect the inclusion rate that applies to the year in which the net capital loss is deducted (2023). The result is that the capital loss of $6,000 from 1998 fully offsets the capital gain of $6,000 from 2023.

These adjustments may also be required when losses are applied to periods before or after the inclusion rate date change of June 25, 2024. The government set out a table of adjustment factors to be applied to the capital loss, depending on the year it was realized.

For example, if a capital loss was realized in 2023 when the inclusion rate was 50 per cent and is to be applied in 2024 to capital gains with an inclusion rate (for gains above $250,000) of two-thirds, the inclusion rate adjustment factor is 1.33, so a net capital loss in 2023 of $50,000 becomes a net capital loss of $66,667 after June 24 ($50,000 times 1.33) when applied to gains of more than $250,000.

Let’s look at a second example. In 2025, Ali has a capital gain of $450,000, a capital loss of $50,000 and a capital loss carried forward from 2017 of $300,000. First, we calculate Ali’s net capital gain for 2025, which would be $400,000 ($450,000 minus $50,000, both of which were realized in 2025).

The first $250,000 would be included at a 50 per cent inclusion rate, resulting in a taxable capital gain of $125,000, while the remaining $150,000 ($400,000 minus $250,000) would be included at the two-thirds inclusion rate, resulting in a $100,000 taxable gain. As a result, Ali’s 2025 taxable capital gains would total $225,000.

If Ali wishes to apply her 2017 capital loss carried forward of $300,000 to 2025, her net gain for 2025 would be $100,000 ($400,000 minus $300,000), of which only 50 per cent would be taxable since it’s less than $250,000. So, Ali would pay tax on 50 per cent of the $100,000 for a taxable gain of $50,000.

It’s a little trickier for 2024, given that two different inclusion rates apply for this transition year. As a result, taxpayers will need to separately identify capital gains and losses realized before June 25, 2024 (period one), and those realized on or after June 25, 2024 (period two).

Gains and losses from the same period are first netted against each other. Taxpayers will be subject to the higher two-thirds inclusion rate for net gains above $250,000 in period two, to the extent that these net gains are not offset by a net loss incurred in period one.

Let’s say Katy realized a capital gain of $600,000 on June 1, 2024, a capital loss of $75,000 on July 25, 2024, and a capital gain of $475,000 on Oct. 1, 2024. Katy’s period one gain of $600,000 is 50 per cent taxable for a taxable gain of $300,000. Her period two net gain is $400,000 ($475,000 minus $75,000).

Katy would pay tax on 50 per cent of the first $250,000 of this $400,000 gain, and pay two-thirds tax on the remaining $150,000 of the gain, so that her period two gain would be $225,000 (half of $250,000 plus two-thirds of $150,000). As a result, her total 2024 taxable gain would be $525,000, consisting of her period one gain of $300,000, plus her period two gain of $225,000.