How to Offset Capital Gains Tax on Real Estate in Canada
Changes to Canada’s capital gains tax rules may affect your children if you plan to pass down a property, like the family cottage. The good news is, you can let life insurance pay for capital gains so your kids don’t have to.
Many parents and grandparents make plans to leave properties to their children, grandchildren, or family members as part of their estate plan. It’s a great way to preserve cherished memories and give future generations a leg up financially.
Changes to Canada’s capital gains tax rules may affect your family if passing down a property (like your family cottage or a second home) is part of your legacy plan. This is because when you make money on the sale of an asset such as real estate, stocks or bonds, the government views it as a form of income and they impose a capital gains tax. Here’s how it works:
As of June 25, 2024, the capital gains tax on eligible profits over $250,000 in any tax year will jump to 66.6 per cent from 50 per cent. That sounds like a big hike, but the higher rate will only apply to profits above $250,000. So if you have profit of less than $250,000, nothing changes. To put it in perspective:
- The new rules will only affect about 0.13 per cent of Canadians, with an average annual income of about $1.4-million1.
- You can still sell your primary residence and not pay capital gains.
- Of the 39 million Canadians, 28.5 million are not expected to have any capital gains income at all2.
Some of these changes may affect your estate at the time it transfers to your heirs. How great an effect it has on their inheritance comes down to how you plan for the future now.
When do you have to pay tax on capital gains?
Capital gains taxes are only applied when you sell an asset, like investments or a cottage, and receive the profit. This is called realizing the gain.
For example, if you purchased a cottage for $600,000 in 2000 and sold it in 2020 for $1,000,000, you have to report a capital gain of $400,000 in the 2020 tax year. Under the new rules, here’s how your capital gain is calculated:
| The amount of your capital gain | How you get taxed* |
|---|---|
| $250,000 | 50 per cent of the capital gain is added to your income. (50% of $250,000 = $125,000) |
| $350,000 | 50 per cent of the first $250,000 is added to your income (50% of $250,000 = $125,000). Then, two-thirds of the additional $100,000 gets added to your income before your final tax bill gets tallied. (66.6% of $100,000 = $66,700). |
| The bottom line | In this scenario, your final tax bill is based on three things: 1. Your income (other than capital gains) 2. 50 per cent of the first $250,000 in capital gains 3. Plus, 66.6 per cent of capital gains over $250,000 |
*Tax planning is complicated and requires up-to-date knowledge of the tax code and the current best strategies to minimize the amount you pay. Consult with a tax expert for guidance and peace of mind.
While you’re alive, you have control over when you choose to realize a capital gain. For example, if you buy shares in a company that keep going up in value, you don’t have to sell them until you want to. You could wait decades to sell them all, or dispose of just enough to keep you under the $250,000 threshold.
Conversely, you can apply capital losses to your tax return to lower the amount of tax you pay in any given year. A capital loss is money you lost because you sold an investment for less than you paid for it. Using capital gains and losses to minimize your tax bill within the spirit of the law is common practice. If you have a family financial plan, this is something to review with your advisor well before the December 31st, tax year-end.
Who pays capital gains taxes after you die?
When you die, there is less flexibility. Upon your death, the sum of all your assets, which might include real estate, mutual funds, and personal belongings become what’s called your “estate,” which is simply a legal entity that represents you for legal and tax purposes. This is why financial planners use the term estate planning when you draft your will and decide who gets what. In the year of your death, the value of your estate gets appraised to determine if taxes are owed. Any taxes owed must be paid by your spouse, estate, or adult children.
Also in the year of your death, your assets are deemed to have been sold – even if you haven’t sold them – in order to calculate any capital gains or losses for your final tax return. If capital gains taxes are triggered, the tax gets paid out of the estate you left behind. Ideally, your life insurance policy can cover the tax bill.
Fun fact: The term “estate” comes from the Latin word “status.” No wonder we use it to describe how much stuff you have. If there is enough cash in your estate to pay the taxes, your heirs may be able to settle your account without having to sell off any assets that are sentimental or valuable.
It is important that you plan for this and not leave it to chance. There are ways to ensure that your loved ones can afford to pay estate taxes on your behalf, so that they can keep what you worked so hard to accumulate and wish to leave to them… like the family cottage, for example.
Did you know? Serenia Life members can qualify for discounts on wills and powers of attorney. Find out how.
Understanding life insurance tax benefits
The death benefit (i.e., a payment made to designated family members, other loved ones, or the charity of your choice after you die) from a life insurance policy gets paid to your beneficiaries (i.e., the persons you choose to receive your life insurance payment in the event of your death), tax-free. They can do whatever they want with the entire amount. For example, they could use the money to pay the taxes on your estate so that the family cottage can remain in the family.
Liquidity and life insurance
Liquidity refers to how quickly and easily you can get access to money. Some assets, such as cash, are very liquid. You can transfer money instantly online. Many investments such as stocks, mutual funds, and exchange-traded funds can be sold or redeemed in a matter of days. On the other hand, it might take time to find a buyer for things like artwork or vintage cars. And if your estate is complicated, it could take 18 months or longer before your assets can be distributed according to your will. Life insurance payouts are considered highly liquid because the full amount is available as soon as the claim is finalized.
Using life insurance to offset capital gains tax on real estate in Canada
Changes to the capital gains tax rules are a good reminder that the ground can shift at any time when it comes to public policy and tax rates. Because estate plans are long-term and multi-generational, you should assume that the rules will change from time to time, within your lifetime. A good plan is one that lets you react to change with confidence.
Estate planning and capital gains
Instead of hoping that tax rules will remain constant, an estate plan should incorporate strategies that mitigate future hikes or changes to the rules. A very popular way to do this is by purchasing term life insurance or some form of permanent life insurance. Here’s how they both work.
Term life insurance stays in effect for a specific time. It’s typically sold in terms of 10, 20, or 30 years. From a capital gains perspective, you might want to leave your loved ones enough money to pay taxes on things like a cottage so that the asset stays in the family. If you get to a point financially where this is less of a concern you may no longer need life insurance. For example, your adult children may be happy to pay the taxes in order to own the property. It’s much cheaper than buying their own cottage and paying full freight. A term life insurance policy allows you to choose how much and for how long you want to be covered.
Permanent life insurance never expires as long as payments continue to be made. Within a permanent policy, such as whole life insurance, there is an insurance contract that pays a guaranteed amount to your beneficiaries, which includes a cash value3 that grows over time. Between the insurance payout and the value of the cash portion of your policy, your loved ones should find it easy to cover capital gains taxes and still keep the cottage in the family.
A Serenia Life advisor can help you determine the best option for you and your family. They can answer any questions you may have or provide a fresh perspective on your current plan.
Investment growth within life insurance
For those who want to go beyond simply offsetting the impact of capital gains tax, permanent life insurance offers an effective way to create long-term wealth and transfer decision-making to future generations. Here’s a simplified case study to illustrate this approach.
A case study
The Balfours have four children, a family home, and a cottage that’s been in the family for 20 years. The cottage originally cost $200,000, but skyrocketing real estate prices have sent its value to $700,000. That’s a capital gain of $500,000 if they were to leave it to the kids.
The kids love the cottage, but it’s too early to know whether they want to keep it. Would they rather sell it? What if one sibling wants to buy the other three out? Will spouses be put on the deed? These are the difficult questions families have to ask when planning to pass on a cottage. After getting some tax advice, the couple settles on three options:
Option 1. Give the cottage to the kids now
Transferring ownership to the kids will trigger a capital gain on the cottage in the year the transfer happens. This isn’t a great option because the cottage has gone up in value significantly. Under the new rules, the first $250,000 in capital gains is taxable at the old rate of 50 per cent and the additional 250,000 gets taxed at 66.6 per cent, for a total taxable gain of $291,750 (i.e., the amount you will be taxed on).
Option 2. Cover the capital gains with a term life insurance policy
The Balfours could take out a term life insurance policy in an amount that would cover the cost of the capital gains but they have no idea how long they will live or how much the cottage could be worth in 20 or 30 years. Not to mention, tax laws can change at any time. It’s a tough calculation at their age. Thirty years ago, barely anyone had email or home internet. A lot can happen in three decades.
Option 3. Create a wealth generator that keeps all the options open
Using Couples Insurance to take out a permanent life insurance policy gives the cash portion a long time to increase in value since your kids won’t receive the guaranteed life insurance payout until you’ve both passed. This puts time on the family’s side and keeps everyone’s options open. Knowing that the kids will each receive a share of both the death benefit and the policy’s cash value is one way to keep up with rising costs, combat inflation, and prepare the children for potential changes in tax laws.
This case study is a simple illustration of how families can plan ahead to help soften the blow of capital gains taxes. Your plan will be unique to you and your situation, and may change from time as your income increases, you retire, or welcome new family members. The key is to get started, put strategies in place, and adjust them as needed.
Speak with the experts
Everyone must pay their fair share of taxes, but you can offset the impact of capital gains through estate planning strategies that make use of tax-free payouts to your loved ones. If you’re concerned about changes to the tax rules, want to refresh your estate plan, or would like a quick quote on the cost of life insurance, why not book a 15-minute consultation with a Serenia Life advisor?
Disclaimers
1Your questions answered about the proposed capital gains tax changes. CBC News · Posted: Apr 17, 2024 EDT | Last Updated: April 17. Viewed May 2024. Source.
2Ibid.
3Cash values are accessible via a withdrawal, policy loan, or surrender. These may be subject to taxation and a tax slip may be issued.
