Ch8: Capital Gains And Capital Losses

Question 1

What is the definition of a capital gain?

Answer 1

Results from dispositions of a capital asset.
Shares, land, building, etc. not inventory

Question 2

What are proceeds of disposition (POD)?

Answer 2

Selling price of an asset.

Question 3

What is adjusted cost base (ACB)?

Answer 3

Cost of the asset for depreciable and non-depreciable assets.

Question 4

How do you calculate the amount of capital gain/loss?

Answer 4

When you sell at a profit, you get a capital gain and only half is taxable (included in income).
POD - ACB = CG
CG x 50% (inclusion rate) = TCG

When you sell at a loss you get a capital loss and only half is allowable.
POD - ACB = CL
CL x 50% (inclusion rate) = ACL
—> you cannot have a loss on depreciable assets (only on non-depreciable assets, no CCA, e.g., land, investments).

Allowable capital loss can only be applied against taxable capital gain. You only include in income net positive amounts.
ACL can be carried back 3 years and forward indefinitely to a year where you have a net taxable capital gain.

Question 5

Explain expenses related to a sale reduces the gain.

Answer 5

POD
Less:
- ACB
- Cost of disposition (selling cost)
=
Capital gain
x 50% (inclusion rate)
=
Taxable capital gain

Question 6

Adjustments to ACB: What are government grants?

Answer 6

They are deducted from cost.
If the government gives you money to buy the asset, your cost is less (you deduct the amount the government gave you from the cost of disposition).

Question 7

Adjustments to ACB: What are superficial losses?

Answer 7

Selling shares that are losing you money on the last day of December and buying them back in January a few days later to reduce your TCG in the previous year. Capital loss will be disallowed.
- asset sold and identical asset acquired within 30 days.
- any capital loss will be disallowed and added to the ACB of the new acquired asset.

Question 8

Adjustments to ACB: stock option benefit

Answer 8

• employment benefit included in income (ch3)
• benefit also added to the ACB of the shares

Question 9

Adjustments to ACB: negative amount

Answer 9

If you have a negative ACB because of adjustments, the negative amount is added to income as a capital gain and the ACB is restored to 0.

Question 10

Adjustments to ACB: GST/HST/PST considerations

Answer 10

Some amounts are not refundable: PST amounts, GST/HST on exempt supplies.
If not refundable, added to the ACB

Question 11

What are identical properties?

Answer 11

When acquiring identical assets at different times you need to take the average cost to calculate ACB.

Question 12

Adjustments to ACB: partial dispositions

Answer 12

• allocate ACB on a reasonable basis, usually based on % sold.
• sold 10% of an asset, reduce the remaining ACB by 10%, and allocate it to the ACB of the partial asset sold.

Question 13

What are capital gains reserves?

Answer 13

If all of the proceeds of disposition will not be received in cash in the year of disposition you can defer your capital gain.

ITA 40(1)(a)(iii) limits the reserve to the lesser of:
1. (CG)(amount receivable/POD)
2. (CG)(4/5) … year 2 (3/5) … year 3 (2/5)

Max reserve allowed over 5 years because of second calculation

Question 14

What are bad debts?

Answer 14

Bad debts related to a receivable from the sale of a capital asset (e.g., building) is treated as a capital loss.
—> Different from bad debt expense (e.g., inventory)

Question 15

Sales of real property: what is the problem and solution?

Answer 15

Problem: TL on building is 100% deductible, CG on land is 1/2 taxable. Creates incentive for manipulating the allocation.
Solution: limiting the POD for the building in a way that reduced any TL by the amount of CG on the land.

Question 16

Principal residences - what is the CG reduction formula?

Answer 16

You pay taxes on principal residences if you have 2 or more (when you sell).
CG reduction formula = CG - (CG x (years designated as your principal residence + 1 / number of years you owned the home))

Question 17

What are the personal use property (PUP) rules?

Answer 17

Used primarily for enjoyment of the taxpayer (NOT for business).
Gains included in income at 50%, losses not deductible.
Rule 1: minimum POD and minimum ACB = $1,000.
Rule 2: you don’t net losses to gains, only gains included, losses lost.

Question 18

What are listed personal property (LPP) rules?

Answer 18

What are they: works of art (statue), jewelry (necklace, ring), rare books, stamps, coins, paintings.
How is it taxed: gains included in income at 50%, losses applied only against other LPP gains, $1,000 rule.
—> if you have more LPP losses than LPP gains, you can carry them back 3 years or forward 7 years, to a year where you have a net TCG from LPP.

Question 19

What are deferral provisions on small business investments?

Answer 19

Sale of shares is not taxable if you buy other shares with CG.

Eligible small business corporation:
- investee must be CCPC.
- assets cannot have carrying value in excess of $50M.

Qualifying disposition:
- sale of eligible corporation (CCPC).
- held for 185 days (owned shares at least 185 days).

Replacement shares:
- acquired within 120 days of Y/E.
- must be designated replacement shares.

Permitted deferral:
- limited to gain multiplied by lesser of cost of new shares and POD, divided by POD (cannot exceed 1).

ACB reduction:
- permitted deferral is subtracted from the cost of the replacement shares.

Question 20

What are deferral provisions on replacement property?

Answer 20

Involuntary dispositions (fire, bomb, theft, expropriation):
- replacement must occur within 24 months after the year in which the disposition took place.
- if the purchase of the new asset doesn’t occur in the year of the involuntary disposition, you would need to include in income the TCG and Recapture in the year it occurred and then amend the tax return for that year when you make the acquisition.
- usually you amend the tax year with a letter attesting that the new building was acquired within the time limit.
- if the cost of the building is less than the POD of the old building, the CG only gets reduced by the difference. For example if the replacement property cost $1.8M, the CG would be $200,000 (POD old $2M - cost new $1.8M).
- the recapture gets reduced as long as the cost of the new building is greater than the UCC + Recapture deferred.

Voluntary dispositions:
- applicable to former business property (real property used in the business only).
- by end of first year of disposition (12 months).
- same calculations as involuntary dispositions.

Question 21

What are election on Canadian securities?

Answer 21

Allows having all sales of Canadian securities treated as capital property, as a result, profits are CG and losses are CL.
Signed form is mandatory.
No need to worry the CRA will characterize the transaction as business income.

Question 22

What are deemed dispositions?

Answer 22

Deeming rules: require an item to be given a tax treatment that is not consistent with the actual legal form of the item.
—> it is like you sold the asset (even if you did not), so you have to pay taxes.

Coverage: changes in use, departures from Canada, death of an individual.

Question 23

What are the rules for deemed dispositions - change in use principal residences?

Answer 23

1. Principal residence to rental property (elections under ITA 45(2))
   - can elect to have no change in use from personal to business.
   - remains principal residence for 4 years.
   - cannot claim CCA on the property during this time, but need to report the rental income net of expenses.
   - can extend 4 years if the employer requires more.
   - defer taxation until time of sale - eligible for principal residence exemption.
2. Rental property to principal residence
   - deemed disposition/reacquisition at FMV
   - possible TCG and recapture on the deemed disposition
   - can avoid this tax treatment if you elect under ITA 45(3)

*Elections under ITA 45(3)
- you can treat the property as your principal residence for up to 4 years prior to the change in use.
- can only make this election if you never claimed CCA on the property before.

Question 24

What are deemed dispositions - departures from Canada?

Answer 24

Deemed disposition of capital property at FMV
—> deemed to have sold everything you own worldwide at FMV. Calculate CG (e.g., CCPC shares, public shares, real estate outside of Canada, PUP, LPP).

Exceptions (only report when you actually sell):
- Canadian real property
- Canadian business property
- excluded rights and interest (e.g., RRSPS balance)