Part VIII. Capital Gains and Losses Line 127. What is a Capital Gain or Loss?

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1 Part VIII 0 What is a Capital Gain or Loss? Capital Gains and Losses Line 127 A taxpayer may have a capital gain or loss when he/she sells a capital property. Capital property includes such things as: buildings, land, equipment, license, goodwill, franchise rights and shares of a company. If the property is sold for more than what the taxpayer paid for the property, there may be a Capital Gain. If the property is sold for less than what the taxpayer paid for the property, there may be a Capital Loss. 50% of Capital Gains has to be included in income while 50% of Capital Losses can be deducted from other capital gains. Do not confuse Capital gains or losses with the profit or loss from a business. Many businesses purchase and sell inventory items as part or doing business. The profit or loss from the day-to-day sale of inventory items are non-capital and are treated differently than a capital gain or loss. (See part 7). Do not confuse Capital Gains with Recapture of CCA. If a taxpayer has claimed CCA on a capital property, he may have to include recapture of CCA in income if the property sells for more than the UCC (Undepreciated Capital Cost) of the property. For that purpose the selling price cannot exceed the Original Cost of the property. A capital gain will only occur if the property sells for more than the original price plus additions. In some cases the taxpayer may have to include both a Recapture and a Capital Gain in income on the sale of the same property. The sale of a property for tax purposes does not have to be an actual sale. Any of the following are examples of transactions that are considered to be a "sale" of property for tax purposes: exchange of one property for another property given as a gift property is expropriated shares or other securities are converted option to buy or sell property expires debt owed is settled or cancelled property is stolen or destroyed property is transferred to a trust corporation redeems or cancels shares or other securities change in the property's use taxpayer leaves Canada owner dies Basic facts about capital gains and losses 50% of any capital gain has to be reported as income on line 127. Capital Losses can only be claimed against capital gains. Capital Losses not used in the current year can be carried back 3 years or forward indefinitely.

2 The Tax Shelter Training 1 How to Calculate Capital Gains or Losses If a taxpayer sold capital property during the year, the preparer will need to know the following three amounts to calculate any capital gain or capital loss: Proceeds of disposition (A) Adjusted cost base (B) Outlays and expenses (C) To calculate a capital gain or loss, subtract the Adjusted Cost Base and the Outlays and Expenses from the Proceeds of Disposition. The net result, if positive, is a capital gain. A negative amount is a capital loss. Capital Gain (Loss) = A - B C Proceeds of Disposition: The proceeds of disposition is the amount that is received or will be receive for the sale of a property. In most cases, this will be the selling price of the property. Proceeds of disposition could also include compensation received for property that has been destroyed, expropriated, or stolen. Adjusted Cost Base: The Adjusted Cost Base (ACB) is the original cost of the property plus any expenses incurred to acquire it (legal fees, survey etc.). It also includes the cost of additions. Do not add current expenses, i.e., maintenance and repair costs, to the cost base of the property. Outlays and Expenses: Outlays and expenses are costs incurred to sell a capital property. These include: fixing-up expenses, finders' fees, commissions, brokers' fees, surveyors' fees, legal fees, transfer taxes and advertising costs. Completing the Schedule 3 - Capital Gains and Losses Capital gains and losses are reported on the Schedule 3 and then posted to Line 127 of the T1. The schedule consists of 8 section. Section 1 If a taxpayer, who is a Canadian resident, has a gain on the sale of shares of a Canadian Controlled Private Corporation (CCPC), the sale must be reported in Section 1 of the Schedule 3. Caution: DO NOT report the sale of publicly traded shares in this section. A CCPC is a private corporation that is also a Canadian corporation. In order to qualify as a CCPC, a corporation must not be controlled, directly or indirectly in any manner whatsoever, by public corporations, non-residents or a combination of the two. Qualified Small Business Shares are not publicly traded on the stock market. Example: A taxpayer sold 2,653 shares of ABC Corporation, a CCPC, for $15, The legal fees charged by his lawyer was $1, He originally purchased the shares in 2009 for $10, Complete Sections 1 of the Schedule 3.

3 The Tax Shelter Training 2 Section 2 Sale of Fishing License and Boat The CRA considers the gain on the sale of a Fishing Boat and Motor to be taxable as a Capital Gain and is eligible for the Capital gains Deduction. The CRA considers the gain on the sale of a Fishing License to be taxable as ECP (Eligible Capital Property) and is eligible for the Capital Gains Deduction. If the fisherperson had been claiming a deduction for Eligible Capital over the years, refer to T2121 page 5 from the previous year to determine the balance of the Cumulative Eligible Capital. Capital Gains Deduction A taxpayer is allowed up to $375,000 of taxable capital gains tax-free over ones lifetime on certain transactions. This Capital Gains Deduction applies only to the following situations: The sale of qualified small business corporation shares; The sale of qualified farm property; The sale of qualified fishing property (after May 1 st, 2006); or Bringing a reserve into income resulting from the disposition of any of these three types of property. all these cases the taxpayer must have been a resident of Canada throughout the tax year. Here are the details of each of these situations. Qualified small business corporation shares are the shares of a Canadian-controlled private corporation (CCPC) which essentially is a corporation incorporated in Canada or resident in Canada which is not controlled directly or indirectly by one or more non-resident persons, or one or more public corporations. The shares must have been held for at least two years. Qualified farm property includes an interest in a family-farm partnership and eligible capital property, such as milk and egg quotas, as well as farm land and buildings. Qualified fishing property includes fishing licenses and fishing vessels, of course, but also might be an interest in a family fishing partnership or a share in a family fishing corporation. Whether it s farm property, fishing property, or shares in a CCPC, the qualifying property may be owned by you, your spouse, or your common-law partner. A reserve occurs when you have sold a capital property and instead of receiving full payment all at once when you sell it, you get paid for it over several years. Claiming a reserve lets you report a portion of the capital gain in the year that you sell the property.

4 The Tax Shelter Training 3 Example 1 A taxpayer sold his Boat and Motor during the tax year for $67, The boat and motor was purchased in 2005 for $42, CCA had been claimed over the years and the UCC of the boat and motor at the end of last year was $37, The legal fees for selling the boat and motor were $1, He also sold a fishing License for $35, He had purchased the license for $ in 1992 and had claimed that amount as an expense in How to Report the Sale of a Boat and Motor The Capital Gain from the sale of the boat and motor is reported in Section 2 on the Schedule 3. The Recapture of CCA is reported on the CCA Schedule (T2121 page 4). Capital Gains on the sale of the Boat and Motor Since the Boat and Motor was sold for more than the Adjusted Cost Base (ACB), a Capital Gain must be reported on the Schedule 3. Note that only half of the gain will be included in income. The ACB is the original cost of the boat and motor (including legal fess for the purchase) plus the cost of additions that were not claimed as expenses when purchased. Section 2 Bottom of Schedule 3

5 The Tax Shelter Training 4 Capital Gains Deduction - Line 254 Assuming that the taxpayer has not used the full amount of the allowable Lifetime Capital Gains Deduction ($375,000.00), the amount of the gain can be claimed as a deduction on Line 254. This will be done automatically by Cantax when Section 2 on the Schedule 3 is completed. Recapture of Capital Cost Allowance on the Boat and Motor Because the taxpayer had been claiming CCA over the years and the Proceeds of Disposition were more than the Undepreciated Capital Cost, the taxpayer will have to report a Recapture of CCA. Note that for the calculation of Recapture, the Disposal Proceeds cannot exceed the original cost of the Boat and Motor. Note: Disposal proceeds cannot exceed original purchase price plus additions. Recapture of CCA will be posted as income on the T2121 Form The Recapture of CCA ($4,846.00) will be posted as income on the fishing statement. Page 1 of T Statement of Fishing Income

6 The Tax Shelter Training 5 How to report the Sale of a Fishing License The sale of the Licence is reported on page 5 of the T2121 Form. T2121#01-5 Selling price of License. This box must be checked if the taxpayer is a fisherperson

7 The Tax Shelter Training 6 Both the Recapture of CCA from the sale of the boat and motor ($4,846.00) and the Recapture of CEC from the sale of the License ($17,500.00) is posted as income on the T2121 form. The $17, is eligible for the Capital Gains Deduction. $4, $17, T1 - Page 3 Capital Gains ($11,305.00) + Recapture of CEC ($17,500.00) = $28, Example 2 A taxpayer sold his fishing License for $42, in the current year. He purchased the license in 1994 for $18, The Cumulative Eligible at the end of the previous year was $9, Complete page five of the T2121. This situation is a little more complicated. The taxpayer has claimed a deduction for Eligible Capital Property over the years (7% per year). Similar to CCA, the calculation is done on a declining balance based on 75% of the original cost. Since the original cost was $18, the deduction in the first year is based on $13, (75% of $18,500.00). The deduction in the first year would be $ (7% of $13,875.00) leaving a balance of $12, The following year the deduction would be $ leaving a balance of $12, and so on. First year of purchase Second year

8 The Tax Shelter Training 7 In this example the Cumulative eligible capital at the end of the previous year was $9, Since the original deduction was based on $13,875.00, the taxpayer has claimed a total deduction of $4, for Eligible Capital Property over the years. This amount must be reported on page 5 of the T2121. The $4, that had been deducted will be reported as income on the T2121 but is not eligible for the Capital Gains Deduction. The $11, ($15, $4,110.00) is eligible for the Capital Gains Deduction.

9 The Tax Shelter Training 8 Capital Gains Deduction - Line 254 Taxpayers can claim a lifetime Capital Gains Deduction of $375,000. against Capital gains from the disposal of qualified small business corporation shares and qualified fishing and farming property reported in Sections 1 and 2 of the Schedule 3. Cantax will automatically calculate the deduction when the amount claimed in previous years is entered in Part 3a of form 657. If no amount has been claimed in any previous years, the Capital Gains Deduction for the current year will be the full amount reported in Sections 1 and 2 to a maximum of $375,000. The Capital gains Deduction is reported on Line 254. Even though amounts reported in Sections 1 and 2 affect the taxpayer's Net Income, he/she may not have to pay taxes on that amount if the Capital Gains Deduction can be claimed.

10 The Tax Shelter Training 9 Section 3 Report the sale of all publicly traded shares, mutual fund units and other shares in this section. The taxpayer must provide information on the number of shares, the purchase price, the selling price and any outlays and expenses related to the purchase or sale. Example: In 1999 a taxpayer and her spouse purchased 500 publicly traded shares of ABC Co. for $ per share. They incurred a broker s fees of $ This year they sold those shares for $ per share. As part of the sale they incurred broker s fees of $ The taxpayer and her spouse each owned 50% of the shares. They also sold 200 hundred shares of XYZ Co. for $37.67 per share. The broker s fees for the sale were $ In 2001 they purchased those shares for $76.20 per share. Broker s fees for the purchase were $ The taxpayer s spouse owned a 25% share of XYZ Co. ABC Co. Proceeds of Disposition: $ X 500 = $82, Adjusted Cost Base: $ X $475.00= $63, Outlays and Expenses: $ XYZ Co. Proceeds of Disposition: $37.67 X 200 = $7, Adjusted Cost Base: $76.20 X $347.00= $15, Outlays and Expenses: $ Information for the sale of publicly traded shares must be reported in Sec 3 of the Schedule 3. Identical Shares Properties of a group are considered to be identical if each property in the group is the same as all the others. The most common examples of identical properties are shares of the same class of the capital stock of a corporation or units of a mutual fund trust. A taxpayer may buy and sell several identical properties at different prices over a period of time. If so, he/she will have to calculate the average cost of each property in the group at the time of each purchase to determine the ACB. The average cost is calculated by dividing the total cost of identical properties purchased (this is usually the cost of the property plus any expenses involved in acquiring it) by the total number of identical properties owned.

11 The Tax Shelter Training 10 Example: In 1995, Cathy purchased 100 shares of Lotas Co. for $15.00 per share. In 1996 she purchased an additional 150 of the same shares at $20.00 per share. During the current year she sold 200 shares at $23.75 each. She incurred expenses of $ for the sale. Later during the current year she purchased 350 additional shares at $21.00 per share. With each purchase, the Adjusted Cost Base changed. Note: the sale does not affect the Adjusted Cost Base Purchased 100 shares at $15.00 each. Total Cost = $1, Adjusted Cost Base = $15.00 per share 1996 Purchased 150 shares at $20.00 each. Total Cost = $3, Adjusted Cost Base = $ per share Current year Sold 200 shares Proceeds of disposition 200 X $23.75 = $4,750 Adjusted Cost Base 200 X $18.00 = $3,600 When this sale is reported, the ACB used on the Schedule 3 is $18.00 per share. The 200 shares at $18.00 each must be removed from the pool. The remaining pool is 50 shares at $18.00 each for a value of $ Current Year - Purchased 350 shares at $21.00 each. Total Cost = $7, Adjusted Cost Base = $ If she sells some shares before making another purchase, the ACB to be reported on the Schedule 3 is $20.63 per share. Section 4 Report the sale of real estate including land and buildings and any equipment. This section can also be used to report a gain on license and goodwill of a business etc. Example: A taxpayer had a rental property that he paid $123, for in At that time he had legal and survey fees of $ In 1990 he made improvements to the property that cost $21, This year he sold the property for $176, and incurred the following expenses: Legal Fees $ and Real Estate Fees $

12 The Tax Shelter Training 11 Proceeds of Disposition: $176, Adjusted Cost Base: $123, $ $21, = $145, Outlays and Expenses: $ $4, = $4, Capital gain = $26, Proceeds of disposition Adjusted cost base Outlays and expenses Gain (or Loss) Section 5 Report the sale of bonds, debentures and promissory notes. Section 6 Report any non-farming mortgage foreclosures and conditional sales repossessions. Section 7 Report the sale of any personal use property. Most people do not have a capital gain when personal use property is sold. When a taxpayer sells personal-use property, such as cars, boats and furniture, in most cases he/she will not end up with a capital gain. This is because this type of property usually does not increase in value over the years. As a result, he/she may end up with a loss. Although any gain on the sale of personal-use property must be reported, a loss cannot be claimed. If there is a gain on the sale of personal use property, and the selling price is less than $1, the gain does not have to be reported. If the selling price is more than $ the gain should be reported in Section 7 of the Schedule 3.

13 The Tax Shelter Training 12 Section 8 Report the sale of any Listed personal property (LPP). Listed personal property refers strictly to personal-use properties which normally increase in value. These include: prints, etchings, drawings, paintings, sculptures, or other similar works of art; jewellery; rare folios, rare manuscripts, or rare books; stamps; or coins. Since listed personal property is a type of personal-use property, the $1,000 minimum proceeds of disposition also applies. The capital gain from the sale of listed personal property must be reported in Section 8 of the Schedule 3. LLP losses can be claimed only against other LLP gains in the current year or carried back three year or forward indefinitely. Capital Gains or Losses from Information Slips The most common occurrence of Capital Gains and Losses that a taxpayer has to report are shown on an Information Slip (T5, T3, T4PS or T5013). When the information from the slip is entered on the slip screen, the correct amounts are posted to Schedule 3 and the taxable amount is posted to Line 127.

14 The Tax Shelter Training 13 Sale of Principal Residence If a taxpayer sells his/her own home (principal residence) for more than what it cost, he/she usually does not have to report the sale on the T1 return or pay tax on any gain. If the taxpayer has been using part of his/her home as rental property or to run a business, he/she may have to report the sale and include part of the gain as a capital gain. However, he/she does not have to report any gain if: the rental or business use of the property is relatively small in relation to its use as a principal residence (15-20%); he/she did not make any structural changes to the property to make it more suitable for rental or business purposes; and he/she did not deduct any CCA on the rental or business part. If all of the above conditions are met, the whole property may qualify as a principal residence, even though part of it is used for rental or business purposes. However, if the taxpayer does not meet all of the three conditions, he/she has to: split the selling price between the part used as a principal residence and the part used for rental or business purposes. (CRA will accept a split based on square metres or the number of rooms as long as the split is reasonable); and report any capital gain on the part used for rental or business purposes. Renovations will change ACB - The Adjusted Cost Base of a property will be different than the original cost when renovation have been done on the property. This should not be confused with expenses such as repairs and maintenance that have been claimed against rental or business income. Summer Home A gain on the sale of a summer home that is not a persons principal residence is a capital gain and must be reported in Section 4 on the Schedule 3. Example: A taxpayer has been renting 40% of his house since he purchased it in This year he sold the house for $177, and had legal fees of $ and real estate fees $6, related to the sale. He originally purchased the property for $142, and incurred legal, appraisal and survey fees of $1, Over the years he spent $18,900 on renovations to the property. He has not claimed CCA on the apartment. Calculate any Capital Gain or Loss on the property and report it on Schedule 3. The preparer needs three things: (a) Proceeds of Disposition, (b) Outlays and Expenses related to the sale and (c) Adjusted Cost Base. To Calculate Proceeds Selling Price $177, Proceeds of Disposition for Apartment 40% of $177,900 = $71,160.00

15 The Tax Shelter Training 14 To Calculate Outlays and Expenses Apt _ Pr oceeds 71,160 $7,341.00( Expenses ) $2, Total _ Pr oceeds 177,900 Outlays and Expenses for Apartment = $2, To Calculate Adjusted Cost Base Original Purchase Price Cost of Additions (Renovations) Legal and Appraisal Expenses Cost of Property Adjusted Cost Base (ACB) for Apartment $142, , $1, $162, =========== 40% of $162, = $65, Recapture of Capital Cost Allowance If a taxpayer has been using part of a personal residence to carry on a business or has been renting out an apartment, and has claimed capital cost allowance on the apartment, he/she may have to include a recapture of the CCA in income. See Rental Income - Part 6 Recapture of CCA - CRA allows a claim for CCA based on the assumption that the value of the property decreases over time. In reality, some properties (especially buildings) do not decrease in value or do not decrease as much as the CCA that has been claimed. If the property is sold or converted to personal use, and the selling price or fair market value is higher than the UCC (Undepreciated Capital Cost), the taxpayer may have to include some or all of the CCA that was claimed, back into income. This amount to be included in income is called recapture. It will be posted to Line 9947 of the T776. For recapture purposes, the selling price cannot exceed the purchase price. If the selling price is greater than the original purchase price, enter only the original purchase price as Disposal Proceeds on the Capital Cost Allowance Schedule. In that case the Recapture will be the full amount of the CCA claimed, but not more. We do not recommend claiming CCA on rental or business property in a personal residence. In practically all cases the value of the property will not decrease over time, so the taxpayer will have to bring the CCA back into income as Recapture and pay taxes on it at that time.

16 The Tax Shelter Training 15 Changing Personal Residence to a Rental property If a taxpayer moves out of his personal residence and rents the property, he/she may elect, under subsection 45(2) of the Income Tax Act, to have that property continue to be designated as his/her personal residence as long as no other property is designated as his/her principal residence. This may have the effect of reducing any Capital Gain that the taxpayer may incur when the property is sold or converted back to personal use as long as no CCA was claimed. Once this election has been made, the property can still qualify as the taxpayer's principal residence for up to 4 taxation years, even if the property is not inhabited during those years by the taxpayer. However, the taxpayer must still be a resident or deemed resident of Canada during those years in order to designate the property as the principal residence. The taxpayer must include, with the return for the year the change took place, a request, in writing, to make the designation. The property may qualify as the taxpayer's principal residence for more than 4 taxation years if the reason for the change in use is that the place of employment of the taxpayer or the taxpayer's spouse or common-law spouse has been relocated. Deemed Disposition When there is a change in use of real estate, either from rental to principal residence, or from principal residence to rental, there is a deemed disposition. The owner is deemed to have disposed of the property (land and building), and to have immediately reacquired it, with both transactions done at fair market value. Converting Apartment Back to Personal Use Many times a taxpayer decides to convert an apartment in his/house back to personal use. In this case the determination of the Proceeds of Disposition is based on the Fair Market Value of the property. Example: A taxpayer has been renting out 40% of his home. This year he stops renting the apartment and converts it into a recreation room and workshop. He estimates that the FMV of the whole property is $194, The Proceeds of Disposition (for Capital gains calculations) will be 40 % $194, $77, If the taxpayer has been claiming CCA on the rental portion, the FMV of the land must be deducted before determining the Proceeds of Disposition for Recapture or Terminal Loss.

17 The Tax Shelter Training 16 Allowable Business Investment Loss (ABIL) Line 217 A taxpayer has a business investment loss if he/she had shares in, or lent money to, a Canadian small business corporation and, during the year, the business has gone bankrupt or became insolvent and the taxpayer cannot recover his/her investment. Half of the business investment loss is called an Allowable Business Investment Loss (ABIL) and can be deducted from other sources of income. The ABIL that can be claimed may be affected by any Capital Gains Deduction claimed in the current year or in the past. To make the claim, expand a Line 217 and enter the information about the debt or shares. Following is a list of information required: name of the small business corporation number and class of shares, or the type of debt disposed of insolvent, bankrupt, or wind-up date date that the shares were purchased, or the date that the debt was acquired amount of the proceeds of disposition adjusted cost base of the shares or debt outlays or expenses on the disposition amount of the loss To make the claim expand a Line 217.

18 The Tax Shelter Training 17 A taxpayer can deduct the ABIL from other sources of income for the year. If the ABIL is more than the other sources of income for the year, include the difference as part of the non-capital loss for the current year. Non-Capital losses can be carried back three years and forward up to 10 years. Use a T1A form to carry back any losses. If the taxpayer cannot deduct the ABIL as a non-capital loss within the allowed time frame, the unapplied part becomes a net capital loss. This loss can be used to reduce any taxable capital gains in the 11th year or any year after. Note: Any ABIL that you claim for the current year will reduce the capital gains deduction that can be claimed in the current year and in future years. Claiming a Reserve When a taxpayer sells a capital property, he/she usually receives the full payment at that time. However, sometimes the amount is received over a number of years. For example, a taxpayer may sell a capital property for $50,000 and receive $10,000 in the year it is sold and the remaining $40,000 over the next four years. When this happens, he/she may be able to claim a reserve. Usually, a reserve allows the taxpayer to report a portion of the gain over a number of years. Capital Losses If the taxpayer has a capital loss in the current year, he/she can use it to reduce any capital gains in the year, to a balance of zero. If the capital losses are more than the capital gains, the taxpayer will have a net capital loss for the year. Generally, net capital losses can be applied to taxable capital gains of the three preceding years and to taxable capital gains of future years. Property for which a Form T664 or T664(Seniors) was filed Special rules also apply to determine the adjusted cost base (ACB) of a property for which a taxpayer filed a Form T664 or T664(Seniors), Election to Report a Capital Gain on Property Owned at the End of February 22, In most cases, if a Form T664 or T664(Seniors) was filed, the taxpayer is considered to have sold the capital property at the end of February 22, 1994, and to have immediately reacquired it on February 23, By doing so he/she could take advantage of a Capital Gains Deduction available at that time. The ACB then becomes the value declared on the T664 form. Property Inherited or Receive as a Gift If a taxpayer receives a property as a gift or an inheritance, he/she is generally considered to have acquired the property at its fair market value (FMV) on the date it was acquired. Similarly, if a taxpayer wins a property in a lottery, he/she is considered to have acquired this prize at its FMV at the time it was won. Interest and Property Taxes on Land Interest on funds borrowed to purchase vacant land is not deductible, unless the land is earning income such as rental income. The deductions for both interest expense and property taxes for vacant land cannot exceed the net rental income earned from the land after all other expenses have been deducted. If land is earning rental income, the undeducted portion of interest expense and property taxes can be added to the ACB of the land, which will reduce the capital gain when the land is sold. When the land is not earning income, the interest expense and property taxes cannot be deducted, nor can they be added to the ACB of the land.