A capital gain happens when you sell something for more than it cost you. For a tradesperson it most often shows up when you sell the business, dispose of a piece of equipment for more than its depreciated value, or sell a property. A capital gain is not taxed like your regular trade income. Only part of the gain is included in income, and the rules differ depending on what you sold. The distinction between ordinary income and a capital gain is worth getting right, because it changes the tax bill.
What is a capital gain
You have a capital gain when the proceeds from selling a capital asset exceed its adjusted cost base (broadly, what you paid plus the cost of buying and improving it). The gain is the difference. Historically only one-half of a capital gain is included in your taxable income, so a $20,000 gain adds $10,000 to income, taxed at your normal rates. A federal proposal to raise the inclusion rate to two-thirds above a threshold was floated but is not in force as written, so plan on the one-half rate and confirm the current rate with the CRA before you sell anything large.
Where a tradesperson runs into it
- Selling the business. If you incorporated and sell the shares of your company, that is usually a capital gain. The lifetime capital gains exemption can shelter a large gain on qualifying small business corporation shares, which is one of the main tax reasons people incorporate before a sale. A sole proprietor instead sells assets piece by piece, with different treatment for each.
- Selling equipment. This is where trades get caught out. When you sell a depreciated asset, you first have recapture or a terminal loss to deal with under the CCA rules. Recapture (selling for more than the depreciated balance, up to original cost) is ordinary income, not a capital gain. A genuine capital gain on equipment only arises if you sell it for more than you originally paid, which is rare.
- Selling property. Sell a commercial unit, a yard or a rental, and the growth in value above cost is generally a capital gain. Your own home is usually sheltered by the principal residence exemption, but a property used in the business, or flipped, may not be, and a property held as inventory by a builder is taxed as ordinary income, not capital gain.
Worked illustration
You sell a piece of equipment that originally cost $20,000 and has been depreciated down to $6,000, for $9,000.
- The $3,000 above the $6,000 depreciated value, up to the original cost, is recapture, taxed as ordinary income.
- Because you sold below the original $20,000 cost, there is no capital gain. Now sell a yard you bought for $150,000 and improved by $20,000, for $250,000. The $80,000 above your $170,000 adjusted cost base is a capital gain; one-half, or $40,000, is added to income.
Reporting and records
Capital gains go on Schedule 3 of your T1, not on the T2125. Keep the purchase records, improvement receipts and sale documents for everything you might one day sell, because the adjusted cost base is built from them. The six-year record rule runs from the year of disposition for capital property, so do not bin the paperwork the moment you sell.
Common mistakes
- Calling recapture a capital gain. Selling a depreciated asset above its written-down value is usually ordinary income, taxed in full, not a half-included capital gain.
- Assuming every property sale is sheltered. The principal residence exemption covers your home, not a business yard, a rental or a flip.
- Missing the lifetime exemption on a business sale. Selling qualifying company shares can be largely tax-free, but only with the right structure and timing. Plan it well ahead.
- Banking on a proposed rate. Use the one-half inclusion rate and confirm the current figure before a major sale.
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