The prescribed rate is determined by the Canada Revenue Agency (CRA) each quarter and applies to loans made during that quarter. The current interest rate used for low-interest loans is 3% as of Q1 2026.
It fell to 1% in 2020 for 2 years following the pandemic onset and was 1% as well for several years during the 2010s. As a result, lots of taxpayers took advantage of this low threshold and established loans that are still at that same low rate.
Repaying a spousal loan
You are not required to repay a spousal loan, though you are required to make the annual interest payments by January 30 to avoid income attribution. You may need or choose to repay the loan at some point.
The borrower can pay back the spousal loan principal using any source, including the investments purchased with the borrowed funds. The borrower can also use their income or other assets to repay a loan.
Selling investments purchased with the borrowed funds can trigger capital gains.
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Forgiving a spousal loan during your life
If you forgive a spousal loan during your lifetime, special tax rules called “debt-forgiveness rules” may apply to the spouse who borrowed the money. The borrower may have to reduce their non-capital or capital loss carryforwards, if they have any, by up to the amount of the debt forgiven.
Otherwise, they need to reduce the adjusted cost base for depreciable or capital property to increase the future capital gain on sale for these assets.
Any remaining forgiven amount is included in the borrower’s income as a capital gain in the year the loan is forgiven.
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Forgiving a spousal loan on death
A spousal loan is not required to be repaid or forgiven. In fact, it can remain outstanding for many years with the initial interest rate when the loan was made continuing to apply.
If the lender dies and the loan is forgiven upon their death, the debt forgiveness rules do not apply. Nor do the spousal attribution rules apply to income earned from assets purchased by the borrower with the spousal loan.
Summary
Spousal loans require proper documentation, tax reporting, and adherence to the annual interest payment rules.
There can be adverse tax implications if a loan is forgiven. Although a spousal loan does not need to be repaid, there may be cases where it makes sense to do so.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. and Objective Tax & Accounting Inc. in Toronto. He does not sell any financial products whatsoever.
Online valuation tools are convenient, but they rely on broad averages and incomplete data. Municipal tax assessments, on the other hand, are designed for revenue collection, not market precision. Both can be tens of thousands of dollars off the mark.
For example, a property on a busy street might be assessed in line with quieter comparables, inflating its market value. Conversely, a recently renovated home may be undervalued because assessments don’t account for upgrades. These discrepancies matter when you’re refinancing, selling, settling an estate, or dividing assets.
Why professional appraisals trump generic estimates
Unlike generic estimates, a professional appraisal provides a defensible opinion of value grounded in market evidence and industry standards. Appraisers are trained to analyze:
Comparable recent sales with key adjustments
Current market trends and demand
Property-specific factors like condition, renovations, and location influences
Highest and best use of the property
This level of detail ensures that the valuation stands up to scrutiny from lenders, courts, or the Canada Revenue Agency.
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When do you need an appraisal?
There are several situations where a professional appraisal is not just helpful, but essential:
Estate settlements: Executors and beneficiaries need a fair market valuation to avoid disputes and satisfy legal requirements.
Divorce or separation: Courts require unbiased valuations to ensure equitable division of property.
Refinancing or securing a loan: Lenders rely on appraisals to protect against over-lending.
Capital gains and tax reporting: The CRA accepts professional appraisals as credible documentation.
In all of these cases, a miscalculated value can mean paying too much capital gains tax, accepting too little in a settlement, or risking legal challenges.
It’s important to ensure you’re getting an appraisal from a firm with the right expertise, though. Look for one that’s a member of the Appraisal Institute of Canada (AIC), at a minimum. Walson Consulting Inc., for example, is a member of the AIC and the Toronto Regional Real Estate Board (TRREB).
The best appraisers bring rigorous training, ethical standards, and market insight to each report. That credibility is what makes a professional appraisal stand apart from informal estimates—and why lawyers, accountants, and lenders rely on them.
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The bottom line
Your home or investment property is likely your most significant asset. Whether you’re planning, litigating, or simply making a smart financial decision, an accurate, independent appraisal can protect you from costly errors.
In a world where quick online answers are tempting, the real value comes from getting it right the first time.
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Tejveer S. Walia is a designated appraiser with Appraisal Institute of Canada (AIC) and the founder of Walson Consulting Inc., serving homeowners, lawyers, and estate professionals across the Greater Toronto Area (GTA).
Chalk that up as a win for Canadians. Between the tax-free savings account (TFSA), registered retirement savings plan (RRSP), and first home savings account (FHSA), Canadians have ample room to shelter gains from the Canada Revenue Agency (CRA). These registered accounts offer more flexibility and contribution room than Americans get with comparable 401(k) and Roth IRA plans, and they can go a long way if you use them wisely.
That said, whether from windfalls or diligent saving, some Canadians do manage to max out their registered accounts. Once that happens, and until new room opens up in January, the challenge becomes how to keep more of your investment income and gains from getting taxed in a non-registered account.
Some exchange-traded funds (ETFs) are better than others for this. Here’s a guide to how ETF tax efficiency works in Canada and which types of ETFs work best in taxable accounts.
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The ABCs of ETF taxation
In a nutshell, ETF taxes work a lot like the taxes on stocks or bonds, because most ETFs are just collections of those underlying investments. If you’ve ever received a T3 or T5 slip, the categories will look familiar.
The easiest way to see how it works in practice is to check the ETF provider’s website for a tax breakdown. We’ll walk through an example using the BMO Growth ETF (ZGRO), a globally diversified asset-allocation ETF that holds about 80% equities and 20% fixed income.
If you scroll down to the “Tax & Distributions” section on ZGRO’s fund page, you’ll see a table that breaks down the composition of distributions by year. The most recent data for 2024 shows the ETF paid out $0.467667 per unit in total distributions, made up of several different tax categories:
Eligible dividends ($0.082884): These are typically paid by Canadian companies and benefit from the dividend tax credit, which lowers your effective tax rate.
Other income ($0.047890): This mostly includes interest income from the bonds held in ZGRO. It’s fully taxable at your marginal tax rate, just like salary or rental income.
Capital gains ($0.157617): Often from ETF managers rebalancing the portfolio. While not always avoidable, only 50% of a capital gain is taxable, which softens the tax hit. You will also have to pay these yourself if you sell ETF shares for a capital gain.
Foreign income ($0.169810): This comes from dividends paid by non-Canadian companies in the ETF. It’s also fully taxable as ordinary income. Worse, 15% is typically withheld at source (visible as the “foreign tax paid” line of –$0.018009) and may or may not be recoverable depending on the account type.
Return of capital ($0.027475): This is essentially some of your own money coming back to you. It’s not taxable in the year received, but it lowers your adjusted cost base. That means you’ll eventually pay tax on it when you sell the ETF and realize a capital gain. Used properly, this can smooth out distributions, but it can also inflate yield figures.
All of these get taxed differently, which makes ETFs like ZGRO tricky to manage in a non-registered account. In a TFSA or RRSP, you can ignore this tax complexity because none of it applies. But outside of registered accounts, you’ll need to report this all accurately, which can mean more work at tax time.
ZGRO is still a strong choice overall—it’s diversified, affordable, and well constructed. But for Canadian investors focused on tax efficiency, there are cleaner options. ETFs like ZGRO make the most sense in a registered account where you don’t have to worry about this messy tax mix.
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What’s your goal: capital appreciation or income?
Figuring out which ETFs are more tax-efficient starts with defining your objective. Are you investing for capital appreciation, or are you trying to generate regular income from your portfolio?
If your goal is capital growth and you don’t need to make regular withdrawals, say, for retirement income, the focus should be on ETFs that minimize or avoid distributions. This allows the value of the ETF to grow through share price gains rather than payouts, which can defer your tax burden.
One simple way to do this is to choose growth-focused ETFs. For example, the Invesco NASDAQ 100 ETF (QQC) offers exposure to U.S. tech stocks that typically don’t pay high dividends, since they often reinvest profits into research and development and expansion. QQC’s trailing 12-month yield is just 0.42%, mostly foreign income. That level is low enough to render the tax drag minimal.
If you want to go a step further and avoid distributions altogether, some ETF families are designed specifically to do that. A well-known example is the Global X Canada (formerly Horizons ETFs) suite of corporate class, swap-based ETFs. In simple terms, these ETFs use a different fund structure and derivatives contracts to synthetically replicate exposure to equities while avoiding distributions. This has worked well in practice. You could create a globally diversified equity portfolio using:
HXS: Global X S&P 500 Index Corporate Class ETF
HXT: Global X S&P/TSX 60 Index Corporate Class ETF
HXX: Global X Europe 50 Index Corporate Class ETF
But there are trade-offs. These ETFs have seen their fees rise over time. On top of the management fee, they also charge a swap fee and have higher trading expense ratios than traditional index ETFs. This adds to your cost of holding the fund. And because they rely on swaps, you’re exposed to counterparty risk, which is the chance that the other party to the derivative contract (often a big Canadian bank) fails to deliver on its obligation. That’s unlikely but not impossible.
Another caveat is that, while these ETFs are designed to avoid distributions, they can’t guarantee zero payouts. The distribution frequency is listed as “at the manager’s discretion,” largely because of how fund accounting works. And there’s always the risk that tax law changes could alter how these structures are treated, as has happened in the past.
If you’re investing in a taxable account and want to prioritize tax deferral, these ETFs are worth considering, but go in with your eyes open.
Tax-efficient income funds
Personally, I fall into the camp of just selling ETF shares and paying capital gains tax when I need portfolio withdrawals. But I recognize a lot of investors (especially retirees) have a strong psychological aversion to this. This behaviour is known as mental accounting.
No primary residence exclusion available: When selling a second home, you can’t use the primary residence exclusion that allows $250,000/$500,000 in tax-free gains.
Multiple tax reduction strategies exist: Various approaches can help reduce your capital gains tax burden on second home sales.
Key strategies include: Increasing your cost basis with improvements, potentially using 1031 exchanges, or offsetting gains with investment losses.
Understanding second home capital gains
Whether it’s a mountain house in Aspen, CO or a beach condo in Atlantic City, NJ, your vacation home (and any second home) is considered a capital asset under IRS rules. Unlike primary residences, second homes that are not used as primary residences, including vacation homes and investment properties, are considered to be capital assets under IRS rules and do not qualify for the capital gains tax exclusion.
The amount of capital gains tax you’ll owe on the sale of a second home depends on several factors, including how long you owned the property and your income level. For 2025, the long-term capital gains rates are:
0% for single filers with taxable income up to $48,350 and married couples filing jointly up to $96,700
15% for most middle-income taxpayers
20% for single filers with income over $533,401 and married couples over $600,051
High-income earners may also face the 3.8% net investment income tax, making the effective rate as high as 23.8%.
Adjust your cost basis with acquisition costs and improvements
One of the most effective ways to reduce capital gains is to increase your cost basis — the amount you originally paid for the property plus qualifying improvements.
What you can add to cost basis:
Acquisition costs:
Purchase price
Closing costs
Title insurance
Attorney fees
Recording fees
Survey costs
Capital improvements: Capital improvements are permanent repairs or upgrades, not including routine repairs or maintenance. Examples include:
Room additions
Deck or patio installations
New roofing
HVAC system upgrades
Kitchen or bathroom renovations
Landscaping (permanent features)
Security systems
Selling expenses: You can also increase your cost basis by adding any qualifying real estate fees, such as real estate commission and closing costs, paid when selling your second home.
Example: If you purchased your second home for $400,000 and sold it for $500,000, it would initially appear that you profited $100,000. But if you also spent $15,000 on acquisition costs, $20,000 to renovate the bathrooms, $25,000 to put on a new roof, and $30,000 in real estate commission, your cost basis may be $490,000, reducing your taxable gain to just $10,000.
If you’ve rented out your second home, you can claim depreciation deductions that reduce your taxable rental income. However, when you sell, you’ll face depreciation recapture.
If you previously rented out the second home, you may also face depreciation recapture, which means any depreciation claimed during rental years will be taxed at a 25% rate when you sell.
While depreciation recapture adds to your tax burden, the annual depreciation deductions during ownership can provide significant tax benefits that may outweigh the recapture cost, especially if you’re in a higher tax bracket during rental years than when you sell.
Convert your vacation home to a rental property
Renting out the property would allow you to treat it as an investment and claim depreciation and other deductions. Converting your second home to a rental property offers several advantages:
Annual depreciation deductions (typically 3.636% of the property’s value per year for residential rental property)
Deductible expenses, including maintenance, property management, insurance, and property taxes
Potential for rental income to offset ownership costs
This strategy works best if you have time before needing to sell and can generate meaningful rental income.
Revenue Procedure 2008-16 provides safe harbors under which the IRS will not challenge whether a dwelling unit qualifies as property held for use in a trade or business:
For property you’re selling (relinquished property):
Own the property for 24 months before the exchange
Rent the unit at fair market rental for fourteen or more days in each of the two 12-month periods
Restrict personal use to the greater of fourteen days or ten percent of the number of days that it was rented at fair market rental
For property you’re acquiring (replacement property):
Same requirements must be met for 24 months after the exchange
Important: 1031 Exchanges of vacation properties or second homes that do not follow the safe harbor guidelines may still qualify for tax-deferred exchange treatment, but you should consult with legal and tax advisors.
Offset gains with investment losses
Tax-loss harvesting involves selling securities at a loss to offset gains in other investments. According to theIRS Publication 550, if your capital losses exceed your capital gains, you can reduce your taxable income by up to $3,000 for the year and carry forward excess losses to future years underInternal Revenue Code Section 1211.
How it works:
Offset like-kind gains first: Short- and long-term losses must be used first to offset gains of the same type, as outlined inIRS Publication 544
Apply excess losses: If your losses of one type exceed your gains of the same type, then you can apply the excess to the other type
Reduce ordinary income: You can use up to $3,000 in net losses to offset your ordinary income perIRC Section 1211(b)
Carry forward: You can also carry forward any excess losses to offset capital gains and income tax in future years, as specified inIRS Publication 550, Chapter 4
Watch out for wash sale rules: If you buy the same investment or any investment the IRS considers “substantially identical” within 30 days before or after you sold at a loss, you won’t be able to claim the loss. This is governed byInternal Revenue Code Section 1091 and detailed inIRS Publication 550, Chapter 4.
Consider your holding period
If you’ve owned your second home for more than a year, you’ll typically pay a long-term capital gains tax between 0% and 20%, depending on your earnings. Short-term capital gains are treated as regular income and taxed according to ordinary income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% or 37%.
Key timing considerations:
Use tax-advantaged accounts
Assets held within tax-advantaged accounts — such as 401(k)s or IRAs — aren’t subject to capital gains taxes while they remain in the account. While you can’t hold real estate directly in most retirement accounts, you can:
Self-directed IRAs: Some allow real estate investments
Real Estate Investment Trusts (REITs): Hold these in tax-advantaged accounts
Real estate crowdfunding: Some platforms offer tax-advantaged options
Roth IRAs and 529 accounts have big tax advantages — if you follow the account rules, you can withdraw money from those accounts tax-free.
Tax-efficient investment strategies
Beyond tax-loss harvesting, consider these approaches:
Tax-efficient fund selection: Choose index funds or tax-managed funds with lower turnover
Asset location: Hold tax-inefficient investments in tax-advantaged accounts
Rebalancing strategy: Rather than reinvest dividends in the investment that paid them, rebalance by putting that money into your underperforming investments to avoid selling strong performers
Inherited property benefits
If you inherit property, you receive a “stepped-up basis” equal to the fair market value at the time of inheritance, effectively eliminating built-in capital gains. This strategy involves:
Estate planning with family members
Considering lifetime gifts vs. inheritance
Understanding generation-skipping transfer tax implications
Important: This requires careful estate planning and should involve an estate planning attorney.
Convert your vacation home to your primary residence to claim the primary residence capital gains exclusion
Making the property your primary residence can qualify you for the capital gains tax exclusion underInternal Revenue Code Section 121. You may qualify to exclude up to $250,000 of gain from your income, or up to $500,000 if you file a joint return with your spouse, as detailed inIRS Publication 523.
Requirements:
You must meet both the ownership test and the use test — you must have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale, perIRC Section 121(a) andTreasury Regulation 1.121-1(c).
Remember, tax laws are complex and change frequently. The strategies outlined here provide a framework for reducing capital gains taxes, but implementation should always involve qualified tax professionals who can tailor advice to your specific situation.
Frequently asked questions: Minimizing capital gains tax while selling a vacation home
What’s the difference between short-term and long-term capital gains tax rates?
If you’ve owned your vacation home for more than one year, you’ll pay long-term capital gains rates of 0%, 15%, or 20% depending on your income level, as outlined inIRC Section 1(h). Properties held for one year or less are subject to short-term capital gains, which are taxed as ordinary income at rates up to 37%, perIRS Publication 550.
Can I convert my vacation home to a primary residence to qualify for the capital gains exclusion?
Yes, you can potentially exclude up to $250,000 ($500,000 for married couples) by making it your primary residence for at least 2 out of the 5 years before selling, according toIRC Section 121 andIRS Publication 523. However, recent changes limit this strategy for converted properties.
What is the Net Investment Income Tax, and how does it affect vacation home sales?
The Net Investment Income Tax adds a 3.8% surtax on capital gains if your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), underIRC Section 1411 and detailed inIRS Form 8960.
How can I reduce my taxable income in the year I sell?
Consider maximizing retirement contributions, harvesting losses from other investments, timing the sale for a lower-income year, or spreading the sale across tax years using an installment sale underIRC Section 453 andIRS Publication 537.
Should I consider an installment sale?
An installment sale spreads the gain over multiple years, potentially keeping you in lower tax brackets and avoiding the Net Investment Income Tax threshold. This is governed byIRC Section 453 and explained inIRS Publication 537.
Can I gift part of my vacation home to reduce capital gains?
Yes, gifting portions to family members can reduce your overall gain, though recipients receive your cost basis. Each person can exclude gains up to their individual limits if they qualify. Gift tax rules underIRC Section 2501 andIRS Publication 559 apply.
What if I inherited the vacation home?
Inherited property receives a “stepped-up basis” equal to fair market value at the time of inheritance underIRC Section 1014, potentially eliminating most capital gains. This is explained inIRS Publication 551.
Can I do improvements right before selling to reduce gains?
Capital improvements that add value or extend the property’s life can be added to your basis, reducing taxable gain. However, routine repairs don’t qualify unless they’re part of a larger improvement project, perIRS Publication 523.
How does the timing of my sale affect my tax rate?
Your tax rate depends on your total income in the year of sale. Consider selling in a year when you have lower income, are between jobs, or have recently retired. The brackets are outlined inIRS Publication 17.
What records do I need to minimize my tax bill?
Keep records of your original purchase price, all capital improvements, selling expenses, and any depreciation claimed. Documentation is crucial for calculating your basis correctly, as required forSchedule D andForm 8949.
Can I offset gains with losses from other investments?
Yes, you can use capital losses from stocks, bonds, or other investments to offset capital gains from your vacation home sale. Net losses up to $3,000 can offset ordinary income, with excess losses carried forward, underIRC Section 1211.
Should I consider a charitable remainder trust?
A charitable remainder trust can provide income while reducing capital gains taxes and providing charitable deductions. You transfer the property to the trust, which sells it tax-free and pays you income. This strategy is governed byIRC Section 664 andIRS Publication 559.
Let’s look at reporting investment income and capital gains, and which spouse should report the capital gain on a rental property.
Reporting investment income
When you earn investment income like interest or dividends in a taxable investment account, or rental income from a rental property, you need to report it on your tax return.
Taxpayers sometimes mistakenly think they can minimize the tax payable by choosing which spouse’s tax return to report the income on, and in some cases, changing the allocation from year to year. Unfortunately, it does not work that way. The income must be reported by the spouse who earned it. If the asset is truly joint, each taxpayer would report their proportionate share of the income on their tax return.
Reporting capital gains
Like other sources of income, capital gains have to be reported by the person who earned the income. If the capital gain is on a property held in your name only, Zlatko, you cannot report half the capital gain on your spouse’s tax return to reduce tax, nor can you use their registered retirement savings plan (RRSP) room to reduce the taxable income.
Presumably, you have been reporting 100% of the rental income on your tax return annually, so to change that reporting suddenly when there is a big income inclusion from the capital gain is not an option. If you were reporting the income incorrectly all along, and it should always have been reported jointly, you should go back and adjust your tax return and your spouse’s tax return. Interest would apply on your spouse’s balance owing, and you would receive a refund. But you should have a good reason for the oversight, as the Canada Revenue Agency (CRA) does not like this sort of “convenient” retroactive tax planning.
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Legal versus beneficial ownership
You mentioned that the property is in your name. For tax purposes, there is always a distinction between legal ownership and beneficial ownership.
An asset can be legally owned by one spouse but beneficially belong in part or in whole by the other. If you both contributed equally to the down payment for the property, for example, you should report the capital gain equally, despite the property being held in your name alone, Zlatko.
However, if this was inconsistent with the past reporting of the rental income, that means you may have been reporting the property incorrectly all along. It does not sound like this is the case for you.
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Spousal attribution
On the other hand, if your spouse gave you the money for the down payment, so that the property technically belongs to them beneficially, the income may be subject to attribution. If both spouses have contributed differing amounts at different times, it can be more complicated to determine beneficial ownership for tax purposes. It bears mentioning that spouses can own an asset in a proportion other than 50/50 as a result.
Spousal attribution is when income is earned by one spouse, but because of the source of the funds that generated the income, that income gets taxed back to the contributing spouse.
If your spouse actually bought this rental property in your name to try to reduce tax, it may be that the capital gain and all the past rental income should technically be taxed to them, Zlatko.
Transferring assets between spouses
Sometimes, people ask me about transferring an asset to their spouse, or adding their spouse’s name to the property prior to selling it. A transaction like this runs into the same spousal attribution issue, where an asset you own, transferred to your spouse, will have resulting income taxed back to you.
As a result, you cannot transfer partial ownership to your spouse in an attempt at last-minute tax planning.
Tax reduction options
You brought up contributing to your and your spouse’s RRSPs, Zlatko. This is definitely one way to reduce your taxable income in the year you sell the property. If the capital gain is large, or your income is relatively high besides the capital gain, you may be able to offset about $2 of capital gains with every dollar contributed to your RRSP.
This is because only half of a capital gain is taxable. So, you would only need a $50,000 RRSP contribution to fully offset a $100,000 capital gain.
If you can control your income in the year of the capital gain by reducing or avoiding other sources of income, you may be able to mitigate some of the tax payable on the capital gain, as well. For example, if you are a business owner who can lower your salary or dividends, or you can defer other capital gains or registered account withdrawals, or you can claim or accelerate other tax deductions.
Registered education savings plans (RESPs) are used to save for a child’s post-secondary education. Contributing to an RESP can give you access to government grants, including up to $7,200 in Canada Education Savings Grants (CESGs), typically requiring $36,000 of eligible contributions. The federal government provides matching grants of 20% on the first $2,500 in annual contributions. You can catch up on shortfalls from previous years, to a maximum of $2,500 of annual catch-up contributions. But there is a lifetime limit of $50,000 for contributions for a beneficiary.
If a child is a teenager and there are a lot of missed contributions, the year-end could be a prompt to catch up before it’s too late. The deadline to contribute and be eligible for government grants is December 31 of the year that a child turns 17. And you need at least $2,000 of lifetime contributions, or at least four years with contributions of at least $100 by the end of the year a beneficiary turns 15, to receive CESGs in years that the beneficiary is 16 or 17.
Year-end may also be a prompt for withdrawals. The original contributions to an RESP can be withdrawn tax-free by taking post-secondary education (PSE) withdrawals. When investment growth and government grants are withdrawn for a child enrolled in eligible post-secondary schooling, they are called educational assistance payments (EAPs) and are taxable. If a child has a low income this year, taking additional EAP withdrawals from a large RESP may be a good way to use up their tax-free basic personal amount.
RRSP withdrawals, or RRSP-to-RRIF conversion
If you’re considering registered retirement savings plan (RRSP) contributions to bring down your taxable income, year-end does not bring any urgency. You have 60 days after the end of the year to make contributions that can be deducted on your tax return for the previous year.
If you are retired or semi-retired, year-end is a time to consider additional RRSP or registered retirement income fund (RRIF) withdrawals. If you are in a low tax bracket, and you expect to be in a higher tax bracket in the future, you could consider taking more RRSP or RRIF withdrawals before year-end.
If you are 64, you may want to consider converting your RRSP to a RRIF so that withdrawals in the year you turn 65 can be eligible for pension income splitting. This allows you to move up to 50% of your withdrawals onto your spouse’s or common-law partner’s tax return. If you are still working or you have variable income, this approach may not be best, since RRIF withdrawals are required every year thereafter.
If you are 71, the end of the year does bring some urgency, because your RRSP needs to be converted to a RRIF by the end of the year you turn 71. You can also buy an annuity from an insurance company. You will typically be contacted before year-end by the financial institution where your RRSP is held to open a RRIF.
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TFSA contributions
For those investing or saving in a tax-free savings account (TFSA), year-end is not a significant event. TFSA room carries forward to the following year, so if you do not contribute by year-end, you can contribute the unused amount next year.
Yes, there is a chart that can help; check it out here. However, you’ll still need to calculate any taxes, preferably using tax software to make the math automatic, to get to net federal taxes payable on line 42000 first.
Will CPP and EI premiums make a difference to annual income taxes?
The answer is both yes and no. The self-employed, who are unincorporated and have net business income to report, may be required to make a payment of CPP (Canada Pension Plan) contributions. It may also include EI (Employment Insurance) premiums, if the taxpayer has opted to participate in EI.
CPP and EI are in addition to taxes otherwise payable. If you are required to make quarterly tax installments, these payments are included in the required remittances. But if the balance of income taxes payable, without the CPP/EI premiums, is less than $3,000, those premiums will not be added to the installment remittance threshold.
Top five questions about quarterly tax installments
Here are some common questions Canadians have around tax installments.
What happens if I am late paying a quarterly tax bill?
As mentioned, if you are not using the CRA’s billing method, you’ll be charged interest on late or insufficient installment payments when the T1 return is filed and that can sting. At the current quarterly prescribed rate (9% at the time of writing) that can add up quickly, as that interest is compounded daily.
It is possible to offset the compounding interest accruing when your installments are late or insufficient? Simply make the next payment early or pay more than you calculated the next payment to be.
What are the penalties of not making a quarterly tax payment?
In some cases, late or deficient installments will attract penalties if you will owe a lot of money at tax filing time. What’s a lot? CRA’s interest charge has to exceed $1,000. The penalties are 50% of the interest payable, less the greater of $1,000 and 25% of the installment interest. The penalty is calculated as if no installments had been made for the year.
What if my income changes from year to year?
If you qualify for quarterly tax remittances, you can reduce your income that is subject to tax with an RRSP or first home savings account (FHSA) contribution or by making sure that other larger deductions like child care, moving, or non-refundable tax credits like tuition, medical expenses or donations are all claimed in full.
At a time when Canada, just like every other country, is looking for highly skilled workers, our tax rates make it more difficult for them to choose to work here. This is equally true for Canadian citizens and potential new immigrants. Anecdotally, I’m hearing more and more from clients and people in my network that their children who have chosen to study abroad aren’t coming back home because they can earn and keep more of their income elsewhere. I’m not surprised.
Our high tax rates also make it hard to attract investment into our country and for existing businesses to expand. That is essential to improve productivity, innovate, create jobs and compete against peers in lower-tax jurisdictions.
The Allan Small Financial Show, featuring three tax experts—Fred O’Riordan of Ernst & Young, Jake Fuss of The Fraser Institute and Tim Cestnick, a Globe and Mail tax columnist and CEO of Our Family Office—originally aired on September 18, 2024.
Let’s explore a flat tax
We need a better, more thoughtful tax strategy as a country—one that is fair for everyone. Canada has not taken a hard, comprehensive look at our tax system since 1962, when Prime Minister John Diefenbaker appointed the Royal Commission on Taxation.
At the very least, it would be an opportunity to streamline what is a very complicated system, as I see it. At best, it may point to a better way forward. One potential way to streamline our tax system, and make it more efficient and fair, is to implement a flat tax rate across the board. This is not a new concept for taxation.
For the past decade, Estonia has reaped the rewards of having the most competitive, simple and transparent tax system in the OECD. Its personal and corporate tax rates are 20%. It’s set to increase to 22% in 2025 to match its consumption tax, which increased from 20% to 22% in 2024. In the case of individuals, the tax rate does not apply to dividend income; and businesses only pay tax on distributed profits.
The result: the country has been very successful attracting startups and investment.
And we don’t have to leave Canada for an example of a flat tax. From 2001 to 2014, Alberta had a single 10% personal and business income tax rate, dubbed the Alberta Tax Advantage. The Fraser Institute is now calling for Alberta to implement an even lower flat tax of 8% on personal and business income to attract people, businesses and investment in the province and to encourage spending. When Canadians pay less tax, they have more to spend and put back into the Canadian economy.
Another potential way to ensure tax fairness and generate revenue to meet government responsibilities is to foster more opportunities for the public, business and government to collaborate. For example, why not give individuals and businesses the ability to invest in infrastructure projects, such as new roads and highways, and get a rate of return over time.
The act of adding a name to a property itself does not give rise to capital gains tax. There’s a distinction between legal ownership (whose name is on title) and beneficial ownership (who technically owns the property). If only legal ownership changes, and not beneficial ownership, there may not be a tax event.
For example, an elderly parent might add their child’s name to their bank account or to the title to their home. They might do this based on the perception that it will simplify dealing with the assets as they age, or in an attempt to avoid probate tax. In these situations, a power of attorney or similar estate document (depending on the province or territory) may be better. The asset may not fall outside of the estate and avoid probate if beneficial ownership remains with the parent. There can also be risks to adding a child’s name to title, including creditor issues if the child is sued, family law disputes if the parents divorce, and elder abuse given the children can access the asset.
Was there a deemed disposition?
In your case, Flo, it sounds like your husband intended to partially dispose of the property. Did he document this specifically with a lawyer, or did he just add your daughter’s name to the rental property? Is she now receiving half the rental income?
A true intention to transfer results in a deemed disposition of one-half of the property at the fair market value. It’s equal to selling part of the property, with tax payable when your husband files his tax return next year.
Dealing with the increased capital gains inclusion rate
It seems your husband added your daughter to the property title because of the increase in the capital gains inclusion rate on June 25, 2024.
Beginning on that date, the inclusion rate for individuals rose from one-half to two-thirds for a capital gain of $250,000 or more in a single year. This means two-thirds of the capital gain is taxable instead of just one-half (as was the case prior to June 25). It’s only the capital gain in excess of $250,000 that is taxable at the higher rate. (For corporations and trusts, the inclusion rate is two-thirds for all capital gains.)
You mention, Flo, that this was done for estate planning purposes. I assume you intend to hold the property for the rest of your lives. If that could be many years, it may not be advantageous to accelerate the payment of capital gains tax. Some of the capital gain will still likely be subject to the higher inclusion rate—no matter what—and paying tax earlier than you need to could be disadvantageous.
I’m raising this not as a criticism, but because you may still be able to reconsider, if you haven’t specifically documented your intention and you simply added your daughter’s name to the property title. You should do some tax calculations with your accountant and discuss the documentation of the transfer with your lawyer.
You don’t need me to explain the personal perks of having a vacation home or a cottage. But to many people, a cottage is also an investment. There are costs and hopefully returns, especially if you decide to rent it out. If you hope to buy, find out what you need to pay beyond the listing price and how you might finance the purchase.
Is there a capital gains tax exemption for a cottage?
Sorry to be the bearer of bad news, but there isn’t. There was once a lifetime capital gains exemption of $100,000, but that no longer exists. It only applied in Canada from 1984 to 1994. There are other ways to minimize taxes on the sale of a cottage, though. What about selling to a family member: Can you avoid taxes that way? It depends on a few factors, such as the relationship, if the second property can be claimed as a principal residence, and more.
The short answer: It depends on your relationship to the person who owns it. Are you an extended family member? Their adult child? Or are you their spouse? Find out how inheriting a cottage can affect taxes for a spouse with children and the steps to take to minimize what’s owed.
You mention that the cottage deed is in your name only right now. That suggests that it was either in your name all along or that the cottage was owned jointly with your husband with right of survivorship. I suspect it was held jointly with right of survivorship, meaning that it was transferred directly to you on your husband’s death. That means that it passed outside of his will regardless of his wishes contained therein.
Sometimes the ownership structure of an asset trumps a will, and this may be a case of that, Jill. When an asset passes to a surviving spouse on death, by default, it is transferred at its adjusted cost base for tax purposes, meaning no capital gains tax is payable at that time. The executor can elect to have some or all of the capital gain taxed on the final tax return of the deceased, if it’s advantageous to do so, but let’s assume this didn’t happen. This means that all the accumulated capital gains have been passed along to you and this is important as it relates to the next steps you take with the cottage.
Do you have to share an inherited cottage?
You may not have a legal obligation to include your three stepchildren in the ownership of the cottage, Jill, since the cottage passed outside the will due to joint ownership. If you are in doubt, you should seek legal advice. It sounds like there is at the very least a moral obligation to include your stepchildren in the ownership, but it will result in a gift to your husband’s children—and therefore has tax implications.
Beneficiary of taxes
Because the accumulated capital gains have all been passed along to you, if you gift three-quarters of the cottage to them, you will personally have a capital gains tax liability in the year of transfer. Some people think they can skirt the capital gains tax by making the gift for $1 or for a value equal to the cost, but that’s not the case in Canada. The transfer in ownership needs to happen at the fair market value, meaning the appraisal you suggested may be relevant, Jill. An appraisal is not mandatory when determining the fair market value for a transfer but may be advisable.
Assuming you have sufficient resources to pay the capital gains tax, you may not be worried. But the capital gains tax bill could be a big one if you’ve owned the cottage for a long time.
Keep in mind there are options. You could treat the cottage as your principal residence, with the transfer to your stepchildren, therefore being tax-free. But this would expose your house in the city to capital gains tax on the sale of it or upon your own death.
You need to weigh the pros and cons of paying tax today versus deferring it to determine, if this is advantageous to use the principal residence exemption for the cottage. You may also be limited in doing so if you had a previous principal residence that you sold during the time you have owned the cottage and you treated it as your principal residence, with no capital gains tax payable. This would negate the years you owned the cottage and claimed another principal residence exemption.
According to the Canada Revenue Agency (CRA): “To make this election, attach a letter signed by you to your income tax and benefit return of the year in which the change of use occurs. Describe the property and state that you want subsection 45(2) of the Income Tax Actto apply.”
So, there isn’t a specific form to file to claim this election.
A taxpayer in Canada may be able to extend the four-year limit indefinitely, but this requires your employer or your spouse’s employer to ask you to relocate. It sounds like you relocated in order to look for work, Hugh, so this extension will not apply.
Filing an election late
The 45(2) election is supposed to be filed in the year you move out of the home. The deadline is the tax filing deadline for your tax return that year. This would be April 30 for most taxpayers, and June 15 for those who are self-employed or whose spouse is self-employed.
The CRA can accept a late-filed subsection 45(2) election, if your situation matches one from a list of extraordinary circumstances.
There is jurisprudence to support late-filed election. In Irene Gjernes v. Canada Revenue Agency, the CRA was ordered to reconsider a disallowed 45(2) election that was filed late by the taxpayer despite no extraordinary circumstances.
For the late-filed election, the CRA can levy a penalty of the lower of $8,000 or $100 per month past the due date. If the tax savings are more than the penalty, a late-filed election may be worth the penalty risk.
Capital gains tax when changing the use of a property
Since a home that is converted into a rental property is subject to a deemed disposition at the time of conversion, the fair market value at the time the rental began is the adjusted cost base (ACB) for capital gains tax purposes. A subsection 45(2) election could defer this conversion date.
There are a number of expenses that can be claimed to reduce the capital gain on your cottage, Louise. Capital expenses are an example. The Canada Revenue Agency (CRA) defines a capital expense as an expense that:
Gives a lasting benefit or advantage;
improves the existing property;
is a separate asset; or
is considerable in relation to the value of the property.
Capital gain vs capital expense for the costs of owning and selling a cottage
There’s a distinction between a capital expense—which increases your cost base and reduces your capital gains tax on a property—and a current expense, which is a repair. Repairs are only tax deductible when a property is used for rental or business purposes against the income earned but have no impact on capital gains.
In your case, Louise, a good example of a capital expense would be your expense to change a shingle roof to a metal one. In particular, it provides a lasting benefit, is an improvement to the existing roof, and is considerable in value.
The windows and flooring also provide a lasting benefit. The stove is a separate asset, in its own right. So, these three expenses would also generally be capital expenses that would be added to the cost of the property for capital gains tax purposes.
What is a capital gain?
A capital gain is the increase in value on any asset or security since the time it was purchased, and it is “realized” when the asset or security is sold. (Similarly, a capital loss is realized when you sell an asset that has decreased in value since the time of purchase.) Capital gains (or losses) can happen on stocks, mutual funds and real estate.
The replacement of the old deck and stairs may not be a capital expense, Louise. In fact, the CRA gives a specific example on their website of an expense for wooden steps being a current expense. If you were to replace wooden steps with concrete steps, that would be a capital expense. If you were to repair wooden steps, it would not be a capital expense. It would be a current expense or repair as opposed to a renovation or improvement. So, whether the deck and stair expenses are capital or current would be a matter of fact depending on the exact nature of the work.
Note that the CRA does not give a specific list of capital expenses, but rather, guidelines for determining the nature of the expense.
Cottages for sale: What happens if you have a capital gain?
The calculation of your cost base for tax purposes will then be equal to your original purchase price, closing costs on acquisition, and capital expenses over the years. The proceeds, less the selling costs, less your cost base gives you your capital gain. Half of your capital gain is taxable on your tax return in the year of sale, or two thirds if the capital gain in excess of $250,000 in a given year for a taxpayer. A large capital gain in a high income year could give rise to 25% tax or more depending on your province of residence, income sources, and the magnitude of your capital gains for the year.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
It sounds like you sold or are planning to sell a property in the U.S., Bob. To cut to the chase, selling costs, like a realtor commission, would be deductible on your Canadian tax return.
This assumes the property is taxable, which is typically the case for a foreign property. Interestingly, a property outside Canada can qualify as your principal residence. But this would be unusual for a Canadian resident, whose Canadian home would typically be more valuable than a foreign one, and therefore, more appealing to claim as your principal residence.
Do you have to report the sale in Canada?
Assuming the property in question is a vacation or rental property, the sale would be reported on your Canadian tax return. In addition to your selling costs, Bob, your acquisition costs, including legal fees, renovations or improvements, can reduce your capital gain.
Your capital gain would be calculated based on your net sale proceeds minus the acquisition cost, including renovations. You have to convert these amounts from U.S. dollars to Canadian dollars based on the applicable exchange rates.
The Canada Revenue Agency (CRA) says you should report foreign income or expenses based on the Bank of Canada exchange rate on the date of the transaction. It will accept a different rate for the transaction date if the source is:
Widely available
Verifiable
Published by an independent provider on an ongoing basis
Recognized by the market
Used in accordance with well-accepted business principles
Used to prepare financial statements (if any)
Used regularly from year to year
Bloomberg L.P., Thomson Reuters Corporation, and OANDA Corporation meet these criteria and are “generally acceptable” to use, according to the CRA.
U.S. tax implications of selling property in the U.S.
The U.S. property sale will also have U.S. tax implications, even if you’re not a U.S. citizen. When a Canadian sells real estate in the U.S., they must file a U.S. tax return with U.S. capital gains tax potentially payable. This is a common requirement in other countries as well.
The U.S. tax paid can qualify as a foreign tax credit to reduce your Canadian tax payable, Bob, to avoid double taxation.
Many non-financial assets depreciate in value. Cars, furniture and other such assets tend to be worth less over time, and they are generally not subject to capital gains tax. However, there may be exceptions, such as collector cars, jewellery, artwork or antiques. You may have to report a capital gain on the sale of personal-use property that has increased in value.
To calculate the capital gain—or loss, as the case may be—there are three rules:
If the sale proceeds are less than $1,000, the proceeds are considered to be $1,000.
If both are less than $1,000, there is nothing to report.
Capital gains on personal-use property
As a result of these three rules, personal-use assets are usually a non-issue for taxes. In rare instances where a taxpayer profits, the numbers need to be into the thousands to matter.
Interestingly, when someone buys a burial plot, they actually buy the right to bury, or inter, someone in the plot. That is, the buyer becomes an “interment rights holder,” but they do not own the land itself. Despite this, the empty cemetery plot has value for someone else who will inherit it or buy it.
When the deceased passed away, they were deemed to sell all of their assets, Brian. This includes the cemetery plot. So, capital gains tax would be payable on their death for any appreciation in value.
If you, as executor, sell the plot shortly thereafter, the value will likely be similar. If there’s a profit between the time of their death and the sale of the plot, this could give rise to a capital gain for the estate.
Selling a cemetery plot as part of an estate
It bears mentioning, Brian, the cemetery plot may have some restrictions related to its sale. Keep in mind the land is not owned. The owner holds the right to be buried there. And the cemetery may or may not permit the private sale of interment rights.
Since the plot has a value, it may also be subject to probate or estate administration tax, just like any other asset passing through the estate of the deceased. You should speak to the cemetery, Brian, about the rules around selling the rights to the plot. And consider the tax and probate implications of the individual’s death and the subsequent sale of their vacant cemetery plot.
First off, a transfer of assets between spouses is by default done on a tax-deferred basis at the original purchase price. So, whether the properties are held individually or jointly, either person can transfer their share of the ownership of a house and/or cottage to the other spouse without triggering an immediate tax implication.
They can elect for the transfer to occur at any value between the adjusted cost base and the fair market value. We will come back to this point.
Watch for spousal attribution
When married or common-law couples transfer assets between each other, there’s always the risk of spousal attribution. This may apply if one spouse owns an asset or contributes primarily or exclusively to its purchase and transfers the asset to the other spouse. If the receiving spouse then earns income from it or sells it for a profit, there may be attribution of the income back to the transferring spouse. The income, or capital gain, would be taxable to the transferor.
Spousal attribution does not apply after separation or divorce. So, you can transfer assets and not have to worry about future income being allocated to you down the road. However, there could be lingering tax implications for one or both individuals.
How the principal residence exemption applies in separation or divorce
A couple can only have one principal residence in any given tax year. Your principal residence is not necessarily the place where you primarily live. You can claim your cottage, for example, as your principal residence.
When a separation is amicable, the couple should determine together which property, when treated as the principal residence, would result in the least amount of tax. Specifically, they should consider the annual capital appreciation of each property, calculated as the total appreciation divided by the years of ownership.
Let’s say ex-spouses named Jo and Chris owned a cottage for a short period of time, and it appreciated significantly. They might agree to treat the cottage as their principal residence for the years they owned it. Jo could transfer full ownership to Chris, and they could jointly elect to have the transfer take place at the fair market value. Jo could claim the principal residence exemption to avoid tax in the year of transfer. Chris may be able to claim the cottage as their principal residence for all years of ownership given it will be the only property they own after the separation, and it will qualify for the principal residence exemption in subsequent years as well.
That means Jo will have to pay tax for some years of house ownership, because the cottage was claimed as the couple’s principal residence during the years it was owned. Jo may have some years of ownership before the cottage purchase, as well as more years after the separation, where the house can be their principal residence. But they will have to pay some capital gains tax eventually when they sell the house. It will be based on the total appreciation when they sell it, or die, and the pro-rated years where the couple claimed the cottage relative to the total years of ownership.
If you are going to sell next year, it is worth paying $833 of tax a year earlier? Think of it like debt. Imagine you can buy a refrigerator and you can pay $2,500 today or you can pay $3,333 in a year. Paying in a year costs you 33.33% more. That is a pretty high financing charge.
What about paying that $3,333 in five years? That would be like paying 5.9% interest. Not bad, right? But, because you are paying the so-called “interest” with after-tax dollars, I would say you want a lower interest rate than 5.9% to make it worth it. In other words, if your investments are only earning 5% to 6% per year pre-tax (less after tax), it may not be worth it to effectively pay 5.9% more annually.
For most investors earning a reasonable, mid-single-digit return, you might need to hold an asset for closer to 10 years to end up coming out ahead.
I am not suggesting you sell everything you expect to sell in the next 10 years before June 25. The budget proposals could be changed before enacted. A new government could change the rules again. You may have personal circumstances that make things different for you.
The point here is that if someone is very likely to sell an asset in the next few years that will be subject to the higher inclusion rate, there may be an advantage to doing so before June 25. And, that would generally apply to corporations. For individuals, only assets that would lead to more than $250,000 of tax in a single year.
Ask MoneySense
My wife and I own a cottage that will eventually be passed on to our children and at that point it will be a deemed disposition. My question is: Can the capital gain of, say, $600,000 be split up between both of us, each getting $250,000 at 50% and the remaining $100,000 at 67%?
–Ian
Can you split capital gains between spouses in Canada?
When you die, you have a deemed disposition of assets. That would include a cottage. Although a cottage can qualify for the principal residence exemption, I will assume, Ian, you have a home where you live for which you would instead claim this exemption.
You can leave a cottage to your spouse and have it pass to them at its adjusted cost base without triggering tax. But you have the option of having the transfer value at any price between the cost base and the fair market value. If anyone other than your spouse inherits, there is capital gains tax payable.
This creates an interesting situation with these new changes. If a taxpayer dies and leaves a cottage to their spouse with a capital gain of more than $250,000, there may be situations where you want to declare a partial capital gain on the first death. If the surviving spouse is older, this may be more worth considering. If they are younger, it can be a tougher decision to make to prepay tax that could otherwise be paid many years in the future.
There has been speculation in recent years about an increase in the capital gains inclusion rate. Currently, one-half of a capital gain is taxable, a so-called 50% inclusion rate. Budget 2024 finally introduced an increase but only for certain capital gains.
Capital gains realized by corporations and trusts will now be subject to a two-thirds capital gains inclusion rate instead of just one half. Individuals with a capital gain of more than $250,000 will also pay tax at the higher rate. This rate will also apply to stock option income, by reducing the stock option deduction to one-third for employees with option income exceeding $250,000. This inclusion rate change comes into effect on June 25, 2024.
Lifetime capital gains exemption
The lifetime capital gains exemption applies to business owners who sell qualified shares of their small business corporation or sell their qualified farm or fishing property. The exemption allows a tax-free capital gain of up to $1,016,836 for each taxpayer. The budget proposes to increase this limit for sales after June 25, 2024, to $1,250,000. In 2026, the limit would continue to increase with inflation.
Canadian Entrepreneur’s Incentive
The budget also introduces a new Canadian Entrepreneur’s Incentive, effective January 1, 2025, that reduces the capital-gains inclusion rate on certain taxable capital gains by one-half. It applies to founding investors in certain corporations, but excludes professional corporations, a corporation whose principal asset is the reputation or skill of one or more employees, or businesses in the financial, insurance, real estate, food, accommodation, arts, recreation, entertainment, consulting or personal care services sectors. The limit will be $2 million but introduced in $200,000 increments beginning on January 1, 2025, and reaching $2 million by January 1, 2034.
Alternative Minimum Tax
The government has expanded on the Alternative Minimum Tax (AMT) changes from the 2023 budget. In particular, the AMT calculation for taxpayers with large tax deductions and/or tax credits will now allow 80% of the charitable donation tax credit instead of 50%, so as not to discourage philanthropy. (Read: The best charities to donate to for impact in Canada)
Mineral Exploration Tax Credit
The 15% Mineral Exploration Tax Credit for taxpayers who purchase flow through shares has been extended from the March 31, 2024, expiration date to March 31, 2025.
Other than the increased capital gains inclusion rate for corporations, the budget did not include changes that would impact most small business owners.
The government provided further clarity on the Clean Energy Investment Tax Credit and Clean Technology Manufacturing Investment Tax Credit to purchase equipment used to generate electricity from solar, wind, water, nuclear fission, or geothermal energy, or produce qualifying materials such as cobalt, copper, graphite, lithium, nickel, and rare earth elements.
A call option is an agreement that gives a buyer the right to buy a stock at a predetermined price in the future. The seller is compensated for giving the call option buyer the right (or the option) to buy the investment they own. The option is “covered” if the seller owns the underlying stock. Canadian investors can “write” (sell) a covered call option when they want to reduce the risk of owning an investment.
In 1999, Mark Cuban (the minority owner of the Dallas Mavericks but better known as a panellist on Shark Tank) sold Broadcast.com to Yahoo!, and in return received 14.6 million shares of the company. Cuban was forced to hold Yahoo’s shares (likely due to a lock-in period) and implemented a version of covered calls to protect his position, explains Koivula.
In the example above, Mark Cuban can give another investor the right to purchase one share of Yahoo—let’s say at $100 per share—at a future date. For simplicity’s sake, we’ll assume Cuban’s Yahoo shares are worth $95 each, so he was able to sell the option for, say, $4. Here are two hypothetical outcomes:
Scenario 1: Yahoo’s shares move up to $110 per share. The counterparty exercises their option to buy at $100, and Cuban has to sell it to them at that price. He misses out on the $15 gain, but still has the $4 from selling the option. Cuban ends with $99 instead of the $110 he would have if he hadn’t sold the option.
Scenario 2: Yahoo’s shares fall to $90 per share. The counterparty doesn’t exercise the option because they wouldn’t buy shares for $100 that they could buy for $90. Cuban has lost $5 on the value of his Yahoo share. However, the loss has been offset by the $4 premium from selling the option. Cuban ends with $94 instead of the $90 he would have if he hadn’t sold the option.
You can see that the covered call acts as a kind of dampener on the investor’s overall return, while giving them immediate income ($4 in the example above).
What are covered call ETFs?
Most Canadian investors don’t implement options trades. But they can own covered call ETFs. Covered call ETF providers step in to implement this trade on investors’ behalf, with a larger pool of funds. Global X’s S&P 500 Covered Call ETF (XYLD) is a well-known example of a covered call ETF. In Canada, examples include RBC’s Canadian Dividend Covered Call ETF (RCDC) and CI’s Gold+ Giants Covered Call ETF (CGXF). Use a Canadian ETF screener to find more.
Why are covered call ETFs gaining traction?
Many Canadian retail investors are seeking the highest dividend or yield that they can find in an ETF. In many cases, covered call ETFs come up near the top of that search, says Koivula.
Some of his own clients see covered call ETFs offering eye-popping yields, and they decide to further investigate the opportunity. Indeed, as of Feb 14, 2024, XYLD paid a 10.6% 12-month trailing yield, which, on face value, is a very strong income yield.
ETFs like this can work well in the short-run. Koivula points out that clients like that they’re “getting paid to wait” if they think markets will be flat or down.
Capital gains tax, Nazim, might apply to some of your assets. If you own non-registered stocks or a rental property, for example, they might be subject to a capital gain on your death. Your home would likely be sheltered by the principal residence exemption. A tax-free savings account (TFSA) is tax free, whereas a registered retirement savings plan (RRSP) is not subject to capital gains tax, but is subject to regular income tax. Your RRSP, unless left to a spouse, is generally fully taxable on top of your other income in the year of your death.
The tax is payable by your estate, so although it reduces the inheritance left to your beneficiaries, it’s not payable directly by them. It can be paid with the assets that make up your estate.
Hard versus soft assets
You mention that your estate is made up of hard and soft assets, Nazim. I assume by hard assets you mean real estate. And by soft assets you mean cash, stocks, bonds, mutual funds and/or exchange-traded funds (ETFs).
Your soft assets can be very liquid and used to pay the tax that your estate owes. That tax is not due until April 30 of the year following when your executor files your final tax return. If you die between November 1 and December 31, there is an extension to six months after your death for your executor to file your tax return and pay the tax owing. So, there’s always at least six months to come up with the funds required to pay income tax on death, and there’s more than six months when a death occurs between January 1 and October 31.
Since soft assets are considered sold upon death, there is generally no advantage for your beneficiaries to keep those assets rather than turn them into cash or into other investments of their choosing.
Your hard assets, Nazim, are obviously less liquid. If there is a special property, like a family cottage or a rental property, they choose to keep, I can appreciate how you might want to make sure they can do that without being forced to sell.
Should you buy insurance to cover tax owed upon death?
Your cash and investments may provide sufficient funds to pay taxes owed upon death. Or your beneficiaries may choose to sell one or more of your real estate properties. You could buy life insurance to pay the tax, but I find this strategy is oversold or misunderstood. I will explain with an example.
Let’s say you are 62 years old, and your life expectancy is another 25 years, based on your current health. If you buy a life insurance policy that requires a level premium of $5,000 per year for life, and you pay that premium for 25 years, you will have paid $125,000 to the insurance company. If you instead invested the same amount each year at a 4% after-tax rate of return, you would have accumulated $216,559 after 25 years.
