George thought he’d be smart, screw the feds a little and help his married son at the same time. So he sold the family cottage, worth about $400,000, to Jamie and Pat for a mere $30,000. That was about $300,000 more than he’s paid for it 15 years earlier, when it was a beater property.
“You can gift stuff to others before you croak,” he said. “or sell for whatever you want. This was the smart thing to do.”
Hardly. While Canada has no gift tax (George could have given Jamie a pile of money for a house down payment, no consequences), there’s no way the CRA is letting property change hands without its pound of flesh. In this instance both George and Jamie came in for a hard landing.
Dad’s taxable income was reassessed for the year to include a gain of $270,000. Why? Because regardless of what price George and Jamie decided between them, in the feds’ eyes the property was changing hands at fair market value. So, the difference between George’s purchase price and the market price, less the sale proceeds, was subject to capital gains tax.
As for Jamie, equally nailed. He now owns a $400,000 cottage he paid only $30,000 for. If he sold it tomorrow, he’d have a taxable gain of $370,000. Thanks, dad.
Most people, of course, simply don’t understand how they’re taxed or what to do to minimize the impact. They also don’t realize how the tax system is skewed to ensuring the rich stay that way.
Let’s say you earn $100,000 a year working as a proofreader on this blog (about average at the moment). If you live in BC, you’d take home roughly $75,000, with an average tax rate of 25% and a marginal rate of 38%. (The marginal rate means you’ll lose 38% of every additional dollar earned).
Now if you also have a $2,000,000 investment account and earn 5% in capital gains after your stocks or ETFs increased by $100,000 (and you sold enough to realize the profit), the tax bill would be just $6,250. You keep almost $94,000. See what I mean? And the same holds true for investors who own assets that pay them dividends. It’s not that hard to earn $50,000 a year, and pay zero tax.
The worst way to make money is working for it. Most employees have tax deducted at source, and pay a far higher rate than do investors, who just collect income. Most middle-class people lose about a third of their earned income, and with serious coin (above $150,000), the marginal rate soars to more than 40%.
Ditto for interest earned on assets like GICs, bonds or savings accounts. That’s simply added to your employment income and taxed as such. Rent’s the same. Buy a condo and lease it out and (after expenses) the money you receive is treated as if it were earned on the job. Bummer.
A far better way is to receive capital gains. That’s what happens with a stock or an ETF or an apartment building which rises in value, and is liquidated. Then you’re able to keep 50% of the gain absolutely tax-free. The remaining half is added to your income from all other sources, and taxed at the normal personal rate. That means even the highest-earning person pays a capital gains tax rate of less than 25%, keeping three-quarters of the profit.
Dividends are taxed in a more complex way, but with a similar result. The dividend income is ‘grossed up’ and then reduced by the dividend tax credit (but only for Canadian companies). The net effect is to reduce the tax payable by about half, compared to earned income.
Profits made selling your house are free of capital gains tax, but you can’t deduct any expenses incurred in buying, selling or owning it. If you lose money on an investment you can deduct the loss from capital gains, but if you lose money on your house this break is not available to you.
Personal taxes can be reduced by making RRSP contributions, which reduce your taxable income. But remember all you’re really doing is taking after-tax wealth and making it taxable again – and this sucks when you’re retired and have to pay up. TFSA contributions are not tax-deductible, both neither are the proceeds taxable, which means this should be a cornerstone of your retirement planning.
Mutual funds fees are not deductible from your taxable income. Money paid to have your non-registered investments managed can be written off. Bonds are taxed more than most other assets, so you might as well tuck them inside your RRSP. Things that generate dividends or capital gains should be held in an outside investment account. Self-employed people can often pay themselves in dividends instead of salaries, and slash their tax bills (but they earn no RRSP room). Spousal RRSPs can achieve income-splitting between husband and wife, or finance a maternity leave.
A key element of the Canadian tax system is this: The more you have, the less you pay. For example, savers are given $100,000 in deposit insurance in case a bank fails, investors get over $1 million in protection if their broker rolls.
If life were fair, I’d be taller.