Capital Gains or Income?
Many people constantly wonder whether to have earned income for tax purpose or realize a Capital Gain!!! Distinction between Capital Gain and Income is very important because Capital Gain is only half taxed.
Capital property is where gain is only half taxed (referred to as “Taxable Capital Gain”) at one’s regular marginal income tax rate. Not all gains are capital gains tax. For example, if you buy and sell multiple properties during the year, your income will be considered business income where as if you sell one or two properties in a year, it might be considered a capital gain. Business income is defined as “adventure in nature of trade”. Considering the clarity (or lack thereof) in this definition, there has been numerous court cases. Business losses are fully deductible for tax purpose whereas capital losses are only half deductible and only against capital gains. When you sale items on a regular basis (adventure in nature or trade), its considered business income/losses.
The more confusion comes when it comes to real estate buy and sale. One may buy a piece of land to build a home to live in (Capital), or may plan to sell it after being built (inventory). If you purchase a land to build a commercial unit it may be considered Capital in nature or would be considered inventory if you buy the same piece of land to build homes and then sell them. IT-218R “Profit – Sale of a real estate” provides guidance on CRA’s view on treatment of purchase of sale of a real estate – capital in nature or business profit. Most important here would be the intention. Courts have also developed “secondary intentions” as well. First intention would be to stay in the house but if it does not work out, then sell it would be the secondary intention. In this case, courts have determined the home to be an inventory and capital gains fully taxed. (Refer to IT-459 for more detailed issue discussion).
Principal residence on the other hand has no tax consequences. It’s even better than 50% taxable income of capital gains. However, if one flips home too quickly and intentions are proven that homes are built and stayed in for a short period of time, they are considered business income and taxed at a full amount of gain at the marginal tax rate. This will be true even if you lived in the home and have changed your addresses including on driver’s license. What’s worse is that you will be required to pay HST on the entire purchase price of the home. If you have not kept receipts during construction phase, chances are you will be disallowed the input tax credit on the HST and many builders have taken these things in the past to court have lost cases. In some cases, CRA has known to go after builders after as long as 20 years despite normal statute of limitations being 3 years.
Other well known area in capital gains vs. income is shares. Most of the securities are held as capital property and CRA does not generally argue on the position unless one trades them very frequently. When stocks are traded frequently, it’s considered a business income. If you however have losses, you are in luck because you will be in a better position. You can make an election by filing a form T123 (Subsection 39 (4) of the ITA) to hold all Canadian securities held as capital property forever. Be sure that you do not have losses because losses are considered capital losses and can only be used against capital gains. However, these exclusion does not apply to all shares.
- Exploration and development shares
- Shares or debt you acquired from a person you do not deal at arm’s length with
- Debt to a person or corporation with whom you do not deal at arm’s length
- Private corporation shares whose value is primarily attributable to real property or resource property
Please call our office to see whether you may qualify for an income or capital gain on your venture. We serve Mississauga, Oakville, Brampton and Toronto GTA.