In the proposed Budget 2024, the federal government is amending the Income Tax Act, effective June 25, 2024. This amendment will raise the inclusion rate for capital gains. For corporations and trusts, the rate will increase from one-half to two-thirds. For individuals, the rate will also rise to two-thirds, but only for annual capital gains exceeding $250,000; gains up to this threshold will continue to be taxed at the current one-half rate.
This exemption allows individuals to benefit from the lower inclusion rate for capital gains up to the $250,000 limit. However, they would be affected when selling property or triggering other capital gains that exceed that limit.
What are Capital Gains?
Capital gains are profits earned when selling an asset for more than its purchase price. These gains are realized only when the asset is sold, making them different from income like dividends or interest for taxation purposes. Taxable capital gains can come from assets such as stocks and real estate, including properties like pharmacies.
Corporations vs. Individuals
For corporations and trusts, the inclusion rate on all capital gains will increase from one-half to two-thirds, meaning a larger portion of their capital gains will be taxed. For individuals, the inclusion rate will also rise to two-thirds but only for annual capital gains exceeding $250,000. Gains up to this threshold will continue to be taxed at the current rate of one-half.
Mitigating Factors/Programs
Principal Residence Exemption
Selling your principal residence is exempt from the capital gains tax. You generally need to have lived in the home as your primary residence for at least a year, with exceptions for major life changes like death or divorce. However, secondary properties, such as cabins, recreational properties, or rental/investment properties, will be affected.
Lifetime Exemption
Budget 2024 will see increasing the lifetime capital gains exemption (LCGE) from $1,016,836 to $1.25 million, effective June 25, 2024, and indexing it to inflation going forward. This increase can help mitigate the impact of the higher capital gains inclusion rate.
To qualify, your pharmacy must be a small business corporation at the time of sale, and involve the sale of shares, so sole proprietorships and partnerships do not qualify.
The increased LCGE limit is especially beneficial if the proposed rise in capital gains inclusion rates goes ahead, allowing pharmacists and pharmacy owners to shield more of their capital gains from taxation when selling their practice or generating capital gains.
Alternative Minimum Tax (AMT)
It is crucial to understand how the AMT and personal capital gains are linked. The AMT is a parallel tax system designed to ensure that high-income earners and certain trusts pay a minimum level of tax, even if they use various tax deductions and credits to reduce their regular tax liability. Essentially, you must pay either the AMT or your regular tax, whichever is higher.
In 2024, high amounts of capital gains may lead to AMT applying to pharmacists who pay
tax at the top federal rate of 33%, since the regular capital gains tax rate calculation is 16.5%, or 50% of 33%, and the AMT rate in 2024 would be higher, at 20.5%.
Strategies
If the proposed increase to the capital gains inclusion rate proceeds, leveraging various tax strategies will become more crucial than ever.
Timing the sale of shares strategically, while aligning with your personal and business financial needs, allows effective use of the Lifetime Capital Gains Exemption (LCGE). Selling during periods of low income or offsetting gains with capital losses can minimize tax obligations by reducing your tax liabilities when you are in lower tax brackets.
To preserve your lifetime exemption for crucial occasions like selling your practice, prioritize using tax-sheltered investments, such as RRSPs and TFSAs. This strategy ensures that your lifetime exemption remains available when you need it most.
In certain cases, donating appreciated securities to charity or reallocating corporate capital into permanent life insurance may be suitable solutions to minimize tax liabilities.
Investing for long-term growth and using tax-efficient accounts maximize returns while minimizing tax liabilities, helping to avoid prematurely using amounts available under exemption limits.
Should You Trigger Gains Before The Change?
A key question many are asking is whether it is better to sell an asset and trigger capital gains before the inclusion rate increases.
Before discussing whether you should try to trigger a gain before this deadline, it’s important to realize the June 25th effective date will make such a tight deadline there isn’t sufficient time to respond effectively.
However, you may still be better off not jumping to sell before the change, anyway. According to an RBC study, 2024 Federal Budget – Planning for the Proposed Increase to the Capital Gains Inclusion Rate, using a tax deferral strategy and cost/benefit analysis to assess a breakeven point can be helpful.
Key Considerations Before Taking Action
When planning investments and potential asset sales, assess your time horizon, taking into account any changes in your investment timeline, as well as health and age factors. Ensure your investment goals and risk tolerance align with your portfolio and keep it diversified adequately. Identify any short-term cash needs that you may need to sell assets for. Assess your overall financial picture, including potential net capital gains over $250,000 and what impacts you are expecting on your taxable income and tax brackets.
Tax Deferral
Tax deferral is a tax planning strategy that leverages time factors on the value of money, and needs to be considered when assessing when to trigger capital gains. By deferring taxes, you effectively reduce the present value of your tax liability. This approach allows you to keep more money invested, fostering long-term growth through compounding. On the other hand, selling assets now means prepaying taxes, which results in a smaller amount available for reinvestment.
If you sell right away to avoid an increase in capital gains taxes, you, in effect, prepay taxes and lose the advantages of tax deferral. This is where a break-even analysis can help.
Break-Even Analysis
This assesses the point at which the after-tax value of holding an asset equals selling it now. For example, assuming a 5% annual rate of return, the breakeven point for triggering the gain now and reinvesting is approximately eight to ten years. If you don’t expect to need the funds for that time horizon, you are better off waiting and triggering the tax later, following the strategy of tax deferral. If you require the funds sooner, conduct a cost/benefit analysis considering your time horizon and rate of return to determine the optimal course of action.
Developing the optimal strategy to avoid paying excessive capital gains taxes can be complicated; Pharma Tax can make it easier. Ever-changing tax policies and rules mean reassessing your tax planning and strategies is essential; our experts help ensure your strategies are effective and current, saving you more money.
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