A conversation about taxes doesn’t exactly light up the room everywhere you go. However, they’re such a deeply ingrained fact of Canadian life that they have a way of creeping into discussions in spite of ourselves.
When buying or selling a house, there is serious money at stake. Adding an extra percentage point or two is suddenly something worth talking about.
Capital gains are a particularly contentious topic, especially in terms of real estate. Do you ever pay when buying or selling a house? The answer varies depending on your situation.
Today, we are the absolute life of the party. Yes, we are about to talk all about capital gains and how they might impact your next transaction!
Disclaimer: Tax law is highly specific and subject to legislative changes, so please use this article for information purposes only. For personalized advice, we recommend consulting with a tax professional before buying or selling real estate.
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What Are Capital Gains?
Capital gains are a tax owed on the increase in the value of an asset you own that you have now sold. Think of it as income tax, but on your belongings instead of your labour. Capital property can include stocks, bonds, a business, jewellery, artwork, and, of course, real estate.
Imagine you buy a painting for $100 at a local art festival. Then, as luck would have it, the artist explodes in popularity and you later sell your original print for $100,000. This means you have a gain of $99,900.
Naturally, the government wants in on your good fortune. Currently, capital gains are calculated based on 50% of the increase in value. In the year you sell your painting, you add $49,950 to your income tax return.
This is an extreme example; nevertheless, it illustrates how capital gains work whenever you own an asset that later increases in value. Note: In 2024, the federal government seriously considered raising the capital gains rate to 67% on any asset appreciation of $250,000 per year. Thankfully, this initiative did not go through, and the current rate of 50% still stands.
Do you want more insight as to how real estate transactions work in Toronto? Read the following posts next:
- Can You Sell a House With Open Permits
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- Real Estate Fraud? Yes, It’s A Thing
Your Primary Residence Is Still Exempt
Whenever there is a change in policy, rumours often follow that the Principal Residence Exemption (PRE) is on the chopping block. So far, however, the federal government has offered its reassurances that this fiercely guarded tax break is safe.
That means the house you live in is free from capital gains, regardless of how much it appreciates in value. When it’s time to upgrade or downsize, you can sell your home without worrying about an extra burden come tax time.
When buying or selling a second property, such as a vacation house or rental home, capital gains are very likely to come into play at some point.
Real Estate and Unrealized Capital Gains
Let’s look at a different scenario. You use the equity you’ve built in your primary residence to fund the purchase of an investment property at a price of $500,000. Ten years later, that second home is now worth $600,000.
Technically speaking, you have a gain of $100,000. As long as you remain on the title and hold on to the property, however, there is nothing to pay. Owning an asset that increases in value that you do not sell triggers “unrealized capital gains.” A massive tax burden may exist on paper, but there is nothing to collect as long as ownership status remains unchanged.
Once you sell the property, capital gains apply.
This is where some people might try to get creative to avoid or delay payment. One method is to “sell” the second house to a loved one for $1 or other trivial amount. Since you’re disposing of the property below market value, you technically have a capital loss, not a gain, but the government doesn’t see it that way.
If you bought the house for $500,000, then its fair market value is assessed at $600,000, you are still considered to have a gain of $100,000. The actual selling price doesn’t matter. Even though you have received no money, $50,000 is still added to your taxable income in the year property ownership changes hands.
Planning to sell a house to move on to your next steps? The posts below can help you get the results you need:
- Our Home Selling Success Stories
- How Long Will It Take to Sell My House?
- Everything You Need to Know Before Selling Your First Home
A Generous, Well-Intended Gift Goes Awry
The implications for your family member can be even more detrimental. Let’s go back to that example of the house you bought that is now valued at $600,000. If all goes well in the market, as it usually does with enough time, the property will appreciate even more.
Your gift of allowing your loved one to buy a house for next to nothing certainly seems generous at the time. Who wouldn’t jump at the opportunity? But everyone involved needs to exercise some caution.
In this case, capital gains are likely a moot point since it’s their only property and their primary residence. But if it ever falls outside of the Principal Residence Exemption for any reason, there is the potential for a monstrous tax bill if they ever decide to sell the property. Take a look at these numbers:
If they buy a $600,000 house at $1, they are considered to have a gain of $599,999. All is well as long as the title stays in their name.
However, if they sell it, 50% of the entire value of the house (minus the tiny amount they paid) gets added to their taxable income. It is better to gift the home outright rather than let your loved one buy it at a nominal price, no matter how good your intentions are.
When selling at a more significant amount, but still under fair market value, a conversation with a good financial advisor is in order. For example, paying $400,000 for a home worth $600,000 is still a once-in-a-lifetime opportunity for your family member. However, it’s advisable for everyone to fully understand the possible tax implications. When you go in fully informed and with expert guidance, all parties involved can have an elevated, worry-free experience.
Planning to buy or sell a house this year? Our Toronto luxury real estate agents are here every step of the way. Reach out to ana@asantos.ca or call us at 416.575.7317 with any questions.
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