Capital Gains Tax Increase: Background, Challenges, and Strategies to Reduce Your Tax Liability
Background
As of June 25, 2024, Canada announced an increase in the capital gains inclusion rate from 50% to 66.7% for certain taxpayers; however, the change has been deferred to take effect in 2026. Individuals will continue to benefit from the 50% inclusion rate on the first $250,000 of annual capital gains, with any excess subject to the higher 66.7% rate once implemented. Corporations and trusts will see the 66.7% inclusion rate on all capital gains, without exemption, with implementation expected in 2026.
For rental property investors, this upcoming change introduces significant tax implications when selling properties with large capital gains. Many real estate investors who have benefited from long-term appreciation may face higher tax bills and reduced net profits once the new inclusion rate takes effect.
In 2026, Canadian expects to face increasing the capital gains inclusion rate from 50% to 66.7% for certain taxpayers. While individuals still benefit from the 50% inclusion rate on the first $250,000 of annual capital gains, any gains exceeding this threshold are now subject to the higher 66.7% rate. Corporations and trusts face the 66.7% inclusion rate on all capital gains, with no exemption.
For rental property investors, this change introduces significant tax implications when selling properties with large capital gains. Many real estate investors who have benefited from long-term property appreciation now face higher tax bills, reducing net profits.
The Challenge for Rental Property Investors
Rental properties are typically held for the long term, with investors relying on appreciation for a profitable exit strategy. With property values surging in many Canadian cities, capital gains often exceed the $250,000 threshold, exposing investors to the higher inclusion rate.
Unlike stocks or other financial assets, real estate investors cannot easily spread out capital gains without strategic planning. Additionally, rental income is already subject to full taxation, making this double impact a serious concern for property owners.
Impact of the Change: Case Study
Scenario: Selling a Rental Property with a $1M Capital Gain
A rental property investor sells a property and realizes a $1,000,000 capital gain. Under the previous tax system, only 50% ($500,000) of the gain was taxable. Under the new system, the inclusion rate varies based on the portion of the gain exceeding $250,000:
Capital Gains Breakdown
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First $250,000 → 50% inclusion rate = $125,000 taxable
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Remaining $750,000 → 66.7% inclusion rate = $500,250 taxable
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Total Taxable Capital Gain = $625,250
Tax Comparison (Assuming a 50% marginal tax rate)
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Before June 25, 2024: $500,000 taxable x 50% = $250,000 tax liability
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On Jan 1, 2026: $625,250 taxable x 50% = $312,625 tax liability
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Additional Tax Due: $62,625 more in tax under the new rules
This increased tax burden significantly reduces net profits, making it essential for rental property investors to adopt strategies to mitigate tax exposure.
Key Effects of the Capital Gains Inclusion Rate Increase
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Higher Tax Bills for Large Gains – Investors selling rental properties with substantial gains will see a higher portion of their profits taxed.
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Reduced After-Tax Returns – With more gains included in taxable income, investors keep less of their profits.
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Impact on Retirement Planning – Investors planning to sell properties for retirement funding may face unexpected tax burdens.
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Less Flexibility for Estate Planning – Heirs inheriting rental properties could face higher capital gains tax on deemed dispositions.
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Potential Decline in Real Estate Investment – Some investors may delay sales or seek alternative structures to minimize tax liability.
Strategies to Mitigate Capital Gains Tax
1. Invest Rental Income into Tax-Sheltered Accounts
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RRSP (Registered Retirement Savings Plan): Tax-deductible contributions lower taxable income and defer tax until withdrawal, typically at a lower rate in retirement.
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Example: Contributing $30,000 from rental income reduces taxable income by that amount.
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TFSA (Tax-Free Savings Account): Investment growth is completely tax-free, and withdrawals do not affect taxable income.
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Strategy: Use rental profits to max out TFSA contributions and invest in tax-free assets.
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Permanent Life Insurance (Whole Life or Universal Life): Tax-deferred cash value growth shields wealth from taxation.
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Example: Investing rental income in a whole life policy accumulates tax-advantaged cash value for retirement or inheritance.
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2. Use a Vendor Take-Back (VTB) Mortgage to Spread Capital Gains Over Multiple Years
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Instead of taking a lump-sum payment, sellers can finance the buyer’s purchase and receive payments over multiple years.
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The Capital Gains Reserve Rule allows gains to be spread over up to five years, keeping taxable amounts lower.
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Key Benefit: More of the gain is taxed at 50% rather than 66.7%, reducing total tax liability.
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3. Use the Principal Residence Exemption (PRE)
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If the property was a primary residence for a period, a portion of the gain may be exempt from taxation.
4. Spread Gains Over Multiple Years
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Use installment sales to distribute capital gains over several years, keeping taxable income below the threshold.
5. Offset Gains with Capital Losses
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Apply capital losses from stocks or other investments to reduce taxable capital gains.
In Canada, capital losses can be carried forward indefinitely to offset future capital gains. Additionally, capital losses can also be carried back up to three years to recover taxes paid on previous capital gains.
6. Transfer Property to a Corporation
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Corporations already face a 66.7% inclusion rate, but allow income splitting and potential deferrals, making incorporation an attractive option for some investors.
7. Consider Holding Properties in a Family Trust
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Trust structures distribute income among multiple beneficiaries, reducing individual tax burdens.
8. Donate Property or Shares to Charity
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Donating appreciated assets reduces taxable capital gains while providing charitable donation tax credits.
Post-Mortem Tax Planning for Real Estate Investors
Upon death, all capital assets are deemed disposed of at fair market value, potentially triggering large tax bills. The higher inclusion rate further increases estate tax liabilities.
Estate Tax Reduction Strategies
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Estate Freeze – Locks in today’s capital gains, shifting future growth to heirs.
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Spousal Rollover – Defers capital gains tax when transferring assets to a spouse.
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Life Insurance Planning – Tax-free death benefits help cover estate tax liabilities.
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Trust Planning – Spreads tax liability and ensures efficient wealth transfer.
Final Thoughts
1. Tax-sheltered investments reduce taxable capital gains and grow wealth efficiently.
2. Post-mortem planning prevents large tax burdens on heirs.
📌 Work with a financial, estate planning and tax professional to optimize your strategy!
Capital Gains Tax Calculator (Ontario)
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