Capital Gains Update - Feb 2025

On January 31, 2025, the Canadian government announced a deferral in the implementation of the previously proposed increase to the capital gains inclusion rate. Originally set to take effect on June 25, 2024, the increase has now been postponed to January 1, 2026. This change affects capital gains realized annually above $250,000 by individuals, as well as all capital gains realized by corporations and most types of trusts. The capital gains inclusion rate determines the portion of capital gains that is taxable.

Key Highlights:

• Deferral of Inclusion Rate Increase: The increase in the capital gains inclusion rate from one-half to two-thirds is now scheduled for January 1, 2026, providing individuals and businesses additional time to plan accordingly.
• Maintaining the Principal Residence Exemption: Canadians will continue to be exempt from capital gains taxes when selling their primary residence. Any profit from the sale of a principal residence remains tax-free.
• Introduction of a $250,000 Annual Threshold: Effective January 1, 2026, individuals can realize up to $250,000 in capital gains annually at the current one-half inclusion rate. For instance, capital gains from the sale of a secondary property, such as a cottage, will be eligible for this threshold. This means a couple selling a cottage with a $500,000 capital gain would not face increased taxes due to the inclusion rate change.
• Increase in the Lifetime Capital Gains Exemption (LCGE): Starting June 25, 2024, the LCGE will rise to $1.25 million from the current $1,016,836 for the sale of small business shares and farming and fishing properties. This enhancement ensures that Canadians with eligible capital gains below $2.25 million will pay less tax, even after the inclusion rate increases in 2026.
• Launch of the Canadian Entrepreneurs’ Incentive: Beginning in the 2025 tax year, this incentive reduces the inclusion rate to one-third on a lifetime maximum of $2 million in eligible capital gains. The maximum will increase by $400,000 each year, reaching $2 million in 2029. Combined with the enhanced LCGE, entrepreneurs will benefit from reduced taxes on capital gains up to $6.25 million.

Implications for Tax Planning:The deferral of the inclusion rate increase offers Canadians additional time to assess and adjust their financial strategies. It's crucial to consider how these changes may impact your tax obligations, especially if you anticipate realizing significant capital gains in the coming years.So, what should you do?Consult your tax and investment professionals!Tax is a complex area, meaning specialist expertise and careful consideration of the many variables is key. Referring back to article we published when Budget 2024 was tabled by Liberal government, here are some of the more straightforward opportunities to consider:

• Realizing capital gains before 1 January 2026 may make sense if a short-term sale makes sense. Perhaps you plan to gift money to one of your children to buy a house, or are managing investments for an elderly parent
• Ditto in cases where you are considering trimming a position or rebalancing your portfolio (i.e., you have a large single stock position that you’d like to diversify). If you have sound investment/portfolio construction reasons for rebalancing investments, getting in under the wire makes sense.

Should you realize capital gains pre-emptively regardless?This is a complex question. The answer depends on several factors (and how they are inter-connected):

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That being said, between now and 1 January 2026, Canada faces an election and potential for 2 new budget proposals that could possibly eliminate these new rules all together.

Should you consider changes to your overall investment plan?

Again, probably not. Tax considerations should usually remain secondary in most cases.

Continuing to focus on tax-efficient investment strategies is important. Capital loss harvesting strategies that focus on deferral of gains and realization of losses are examples of this. These strategies may create more value by offsetting future capital gains subject to the higher inclusion rate. Furthermore, transitioning asset in kind into these strategies to defer the realization of gains may also help. Capital losses generated will become more valuable after 1 Jan 2026.

The impact of higher inclusion rates on flow-through shares should also be discussed with your tax advisor. As always, tax rules evolve, and personal financial goals should drive decision-making. Consulting a tax professional will ensure your strategy aligns with both current regulations and long-term objective.