Don’t rush to sell assets due to higher inclusion rate, experts say

The federal government’s proposed increase to the capital gains inclusion rate (CGIR) to two-thirds from one-half will affect most of your clients, not just the wealthiest.

Some of those clients may be anxious to sell assets with large unrealized capital gains ahead of June 25.

“There’s a tremendous amount of uncertainty with regard to this two-month period where people will be potentially executing billions of dollars of transactions,” said John Oakey, vice-president of taxation with CPA Canada, in Dartmouth, N.S.

In the 2024 federal budget, the government proposed increasing the CGIR to two-thirds on capital gains realized in a year above $250,000 for individuals as of June 25. Currently, the CGIR is 50% on all capital gains realized in a year for individuals, not just the first $250,000.

But a rushed sale could be unwise and unnecessary, said Aaron Hector, private wealth advisor with CWB Wealth in Calgary.

For one thing, many clients don’t typically generate $250,000 in capital gains in a year on portfolio investments held personally, meaning there would be no benefit in triggering gains earlier than originally intended.

“They might have gains in their portfolio that well exceed that [threshold], but if you look at it on a year-by-year basis, it’s not like the [entire] portfolio turns over every year,” said Hector, who has been providing clients with a one-page report of the capital gains they’ve generated over the past five years, which in many cases allays their concerns.

Hector also warned that the alternative minimum tax, which the 2024 budget also addressed, could potentially create problems for some clients.

For example, if a client triggers a significant capital gain before June 25 to avoid the higher CGIR, they could find themselves incurring alternative minimum tax if the capital gain represents most of their income for the year.

“That will definitely surprise a lot of people,” Hector said.

Clients can trigger capital gains after any of three life events: when they sell an appreciated property, on the deemed disposition of property if they leave Canada and on the deemed disposition of property on death.

“If those capital gains exceed $250,000, which can happen very quickly in the case of death, the excess is subject to a 66.7% inclusion rate [under the proposed changes],” said Wilmot George, vice-president and team lead of tax, retirement and estate planning with CI Global Asset Management in Toronto.

For corporations and trusts, the higher inclusion rate would apply to all capital gains realized on or after June 25.

Said George: “Once you start introducing thresholds, and different inclusion rates for capital gains based on a threshold, you’re adding complexity.”

The government did not release draft legislation to implement the changes with the budget, further clouding the financial planning picture for clients. In the budget document, the government said it would release “additional design details” about the new CGIR in the coming months.

“The Income Tax Act is extremely complicated,” Oakey said. “If you don’t have the specific rules, you could execute a transaction that, when the rules come out, [results] in an unintended tax result.”

As of press time, enabling legislation had not been tabled.

The budget did indicate there will be two periods for realizing capital gains in 2024. Prior to June 25, all realized capital gains will be subject to the current 50% inclusion rate. From June 25 to the end of the year, clients will be able to realize another $250,000 in capital gains personally before being subject to the higher CGIR.

Ultimately, clients should consider how long they plan to hold an investment, their expected rate of return and whether they expect to be subject to the higher inclusion rate in the year they plan to sell the investment, Hector said.

In general, the longer a client plans to hold on to an investment, and the higher rate of return they expect to generate, the less sense it makes to sell earlier than planned, even accounting for a lower inclusion rate, Hector said.

An earlier-than-planned realization of capital gain is a prepayment of tax, leaving fewer dollars available for investment, George said.

On the other hand, if a client plans to sell an investment in the next two or three years, and they believe the gain on the eventual sale would be subject to the higher inclusion rate, they might benefit from selling before June 25.

Clients with a shortened life expectancy also may decide to realize gains before June 25. “When they pass away, everything is going to be crystallized at that time, and the estate is going to have to pay a tax bill [exposed to the higher CGIR],” Hector said.

Clients can choose to sell an investment to crystallize the capital gain and immediately repurchase it, George said. “Unlike a loss, where you have to wait 30 days to buy back the asset [to avoid the superficial loss rule], in a gain scenario, you can sell it and buy it back right way.”

After June 25, clients can choose to strategically sell assets every year so they never exceed the $250,000 threshold, George said.

As for capital losses, George said there appears to be no benefit or drawback to timing on that front.

In the budget document, the government said a capital loss realized prior to the rate change would fully offset an equivalent capital gain realized after the rate change.

But uncertainty remains regarding how carryforward losses may be allocated in period one and period two in 2024, according to an RBC Wealth Management report on the the proposed CGIR increase.

“If the reason for selling a capital property at a loss is for taxation purposes, you may wish to consider waiting for clarifying details from the government [in draft legislation] to have more certainty before selling,” the RBC report said.

Clients who hold investments in a corporation will lose access to the 50% CGIR on all gains realized in a corporation on June 25.

“Corporate clients may look to move assets to personal name as opposed to corporate name to access the 50% inclusion rate for gains up to $250,000,” George said.

However, the process of accessing cash flow from a corporation involves several considerations, including whether money is sourced from active business or investment income, and in what form: salary, dividend, tax-free payment from the capital dividend account or return of capital.

“The business owner will want to sit down with their corporate tax advisor and run the numbers to see what makes the most sense,” George said.