This article explains what capital property is and what capital gains/losses are.
Capital gains involve capital property, which is exciting because they means the company owns large assets! We start by pointing out the excitement because this article will involve financial terms and tax information which many of us don’t typically find as exciting. As we go forward, keep in mind that underneath the technical financial processes is the exciting concept of owning large assets! Capital gains are important for a business to understand, as there are reporting rules to follow from the Canada Revenue Agency (CRA), and taxes are also involved. Understanding capital gains will help in not paying more taxes than necessary, and will also help to ensure compliance with the Canadian tax code. In this article we clarify what capital property is, explain capital gains vs. losses, as well as tax reporting.
Capital property is considered to be any depreciable property, meaning the value of the property decreases over its lifetime and can be recorded for accounting and tax purposes. These are usually bought for investment purposes to earn income, and will usually result in a capital gain or loss if sold. Capital property does not include the trading assets of a business, such as inventory.
Typical capital property includes:
- Securities – Stocks, bonds, mutual funds
- Land, buildings, equipment, and vehicles used in business operations
- Rental operations
Capital Gains and Losses
A capital gain is when there is an increase in the value of capital property from the original purchase price, whereas a capital loss is a decrease in the value of the capital property. If the current value of an asset the business owns is more than the value when it was purchased, it is a capital gain. If the current value of an asset the business owns is less than the value when it was purchased, it is a capital loss. For example, if a business owns a building that was purchased for $750,000, and the building is now worth $768,000, that would be considered a capital gain of $18,000.
Capital gains and losses are either “realized” or “unrealized.” Realized capital gains and losses occur when the asset is sold. When sold at a higher price than the asset was purchased for, this would be a realized capital gain. When sold at a lower price than the asset was purchased for, this would be a realized capital loss. Unrealized capital gains and losses occur when the value has increased or decreased, however the asset has not been sold. Unrealized capital gains and losses are also referred to as “paper” profits and losses, as the value is simply shown on paper until officially sold.
Calculating and Reporting Capital Gains and Losses
To calculate capital gains and losses, a business must first know the following 3 aspects of the capital property:
- Proceeds of Disposition – Amount received or will be received for the asset. This would be the sale price, or compensation received for destroyed or stolen property.
- Adjusted Cost Base (ACB) – The cost of the asset, plus any expenses to acquire it such as commissions and legal fees. This would also include capital expenditures which includes additions and improvements to the property. This does not include current expenses such as maintenance and repair costs.
- Outlays and Expenses Incurred to Sell Your Property – Amounts incurred to sell the property including fixing-up expenses, finders’ fees, commissions, brokers’ fees, surveyors’ fees, transfer taxes, and advertising costs.
Once the above 3 points have been determined, the capital gain or loss is calculated by subtracting the ACB and Outlays and Expenses Incurred to Sell Your Property from the Proceeds of Disposition.
When a business has capital gains in Canada, they need to pay taxes on them. While this may sound like bad news, making money on an investment isn’t a bad thing! The good news is a business only needs to pay taxes on realized capital gains. The other good news is that a business can use capital losses to offset capital gains which reduces the overall tax that will need to be paid. There are tax laws that apply to capital gains for each taxation year, determined by the CRA. Currently 50% of capital gains are considered taxable, and must be reported on Schedule 3 to the CRA within the same calendar year the asset is sold in. This means for the above example, a taxable capital gain of $1,175 ($2350 ÷ 2) would need to be reported for the year. ½ of any capital losses can be applied against any capital gains in the year. It is important to note that capital losses can be applied to reduce a business’s capital gain in any of the 3 preceding years or in any future years. It is best to consult with your tax accountant to know which strategy will be most advantageous for the business’s tax reporting.
Realizing Capital Gains
From this article we now know what capital property is, the difference between capital gains and losses, realized vs. unrealized gains and losses, taxes that apply, as well as the reporting that needs to be done for realized gains and losses. While we have know that taxes do apply to realized capital gains, it is good to remember that those taxes mean you are making money on an asset! Plus, taking what was learned from this article, we now know that the total taxes can be reduced by offsetting the gains with the losses. While we have heard “knowledge is power,” we can now say knowledge is money! Hey, maybe all this tax stuff can be exciting after all…
Download this resource What Are Capital Gains.