How to Avoid Capital Gains Tax in Canada

Canada recently increased the tax rate on capital gains. So, investors are asking: “how to avoid capital gains tax in Canada”? This post will provide Canadian investors with a few strategies to avoid paying capital gains tax. Especially considering recent capital gain tax rate increases.

Power of Buy-and-Hold

Before discussing ways to avoid capital gains tax in Canada. Let’s consider what makes a successful investment strategy. Because, part of successful investing is avoiding tax.

Long-term buy-and-hold investment strategies typically offer investors the highest rates of return. This is due to three main factors:

1. Reducing emotional bias (since fewer transactions are made)
2. Decreasing costs (since buy-and-hold investing is simple and cheap)
3. Avoiding taxes (since capital gains are eliminated)

Investors are often surprised to learn how powerful returns can be generated by the most simple investment strategies. Including stock market indexing and managing real estate portfolios over generations.

If you’re the kind of investor that’s buying one day, then selling the next. You’ll expose yourself to capital gains tax. And, capital gains tax will be a drag on your returns.

But, if you dutifully accumulate more investments over time with savings and the income from your portfolio. Thoughtfully adding new investments without selling previous ones. Then, capital gains tax won’t be a problem for you.

Avoiding Capital Gains

When investors use long-term buy-and-hold investment strategies, they don’t fear increases to the capital gains tax rate. Because, buy-and-hold investors avoid triggering such taxes. Buy-and-hold investors consistently add to their portfolio of high-quality investments on a regular basis. And, hold them for decades.

But, if long-term investors never sell, how do they ever use the profits from their portfolios? Easy; from the dividends of stocks, interest from bonds, and rent from real estate. Plus, tax loss harvesting and charitable donations.

All these methods provide buy-and-hold investors with opportunities to use the gains from their portfolio, while also avoiding capital gains tax.

Avoid Capital Gains Tax: What Do Successful Investors Do?

Its a funny thing, most good investors are also smart with their finances generally. They live within their means and so generate more than enough income for personal consumption. So, they never need to sell their investments.

Oftentimes, these successful buy-and-hold investors pass on their portfolios to their children and their charitable foundation instead of using their gains for personal consumption.

Ironically, such succession strategies provide lots of opportunities to use charitable tax credits to offset capital gains taxes when the time comes. Including “donate to eliminate” capital gains strategies.

If you’d like to learn more about how our family office helps our clients avoid capital gains tax in Canada using charitable giving, please contact us to learn more.

Sell Now or Sell Later?

I believe an overlooked aspect of increases to the capital gains inclusion rate is the government has purposefully given investors a bit of time to decide what to do. It seems like the government is goading investors into realizing their capital gains when the better strategy is not to.

The government figures that by setting a timeline, they can provoke investors who would otherwise hold for the long-term into realizing their capital gains early. Investors may have the mistaken belief that realizing gains early will help them avoid future higher tax rates.

Don’t fall for this psychological trap. Instead, think long-term. Your portfolio will be far better off when you avoid realizing capital gains taxes. Even if this means paying a higher tax rate in the future. Because, delaying realizing the gains will mean much more capital in an investor’s pocket in the long-run. Such is the power of compounding.

Capital Gains Example

Let’s assume an investor owns a stock worth $100 with a cost base of $50 today in their holdco. They are wondering whether they should sell now to avoid a higher capital gains tax rate in the future.

If the investor keeps their $100 invested for the next 20 years at a 5% annual rate, they will have $265 in 20 years. Compared to an investor who sells now, pays the tax, and then re-invests the proceeds. Such a “trigger happy investor” will be left with just $220.

Then, if both investors sell their investment in 20 years and pay capital gains tax at the same higher future rate, their net positions are $194 (for buy-and-hold investor) vs $174 (for the trigger-happy investor) respectively.

Avoid Capital Gains Tax: Lessons Learned

Oftentimes, it’s better to avoid paying any tax and letting capital compound at the highest rates for as long as possible.

The math changes when the time horizon changes. The shorter the time horizon, the more beneficial it is to sell early before higher capital gains tax rates kick in.

The longer an investor’s time horizon is, the more beneficial it is to avoid selling. If an investor plans to sell an asset a couple of years from now, it might be wise to realize those gains before a recently announced increase to the capital gains tax rate.

But, before making a decision. Investors should work with their tax advisor to determine the numbers. And, avoid guesswork, and “feelings”.

What Does Our Family Office Say?

Navigating capital gains tax in Canada requires strategic planning and a long-term perspective. Embracing a buy-and-hold investment strategy can shield investors from the impact of rising tax rates by avoiding the triggering of capital gains altogether.

By focusing on accumulating high-quality investments over time and leveraging various income sources such as dividends, interest, and tax-efficient strategies like charitable donations, investors can effectively manage their portfolios while minimizing tax liabilities.

Furthermore, resisting the temptation to sell in response to short-term changes in tax policy is crucial. As the power of compounding over the long term often outweighs the immediate benefits of realizing gains early.

If you’re seeking a comprehensive wealth management process designed to optimize tax efficiency and long-term growth, while providing financial peace of mind. We invite you to contact us to explore how we can support your financial objectives.