The planned increase in the capital gains inclusion rate announced in this week’s federal budget has created a frenzy of discussion, worry and anxiety, and, in some cases, the opportunity to get ahead of the change by doing some proactive planning.

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Here’s what’s happening, who may be impacted and what you can do about it.

The changes

Under the current tax rules, if you dispose of capital property (other than your principal residence) for a profit, only half (50 per cent) of the capital gain is included in your taxable income. The budget proposed to increase the capital gains inclusion rate to two-thirds (66.7 per cent) for capital gains realized on or after June 25, 2024. For corporations and trusts, the higher inclusion rate applies to all gains realized on or after that date.

But the rules work a bit differently for individuals. An individual who realizes capital gains on or after June 25, 2024, will still be able to take advantage of the 50 per cent inclusion rate on the first $250,000 of annual capital gains. This $250,000 limit is not prorated for 2024, and only applies to gains realized on or after June 25.

This means all gains realized before June 25, 2024, will be subject to the current 50 per cent inclusion rate, which is the rate that will apply to the first $250,000 of capital gains realized from June 25 onwards. Only any excess gains above $250,000 that are realized after June 25 will be subject to the new 66.7 per cent rate.

What do these new rules mean in terms of actual tax rates? Consider an individual Ontario investor who is in the top marginal tax bracket for 2024 of 53.53 per cent. The current capital gains inclusion rate of 50 per cent means that the marginal tax rate on capital gains is currently 26.76 per cent on any capital gains realized in 2024. This is therefore the top tax rate for capital gains realized before June 25 and will also be the top rate on the first $250,000 of gains realized personally on or after June 25.

But with the new inclusion rate going up to 66.7 per cent for gains above $250,000 after June 25, our Ontario investor would now face a top capital gains marginal tax rate of 35.69 per cent. This rate is 8.93 percentage points higher than the current rate.

It’s important to note that corporations and trusts don’t get the lower 50 per cent inclusion rate on the first $250,000 of annual gains, meaning that from June 25 onwards, all corporate gains will be taxable at the new 66.7 per cent inclusion rate.

Capital gains realized by a trust are generally less problematic since most trusts distribute all their capital gains to their beneficiaries and claim a deduction for those distributions, which are then taxed in the hands of the recipient beneficiaries (as capital gains). Individual beneficiaries could still access the lower 50 per cent inclusion rate for the first $250,000 of capital gains after June 25.

Investors who have capital losses carried forward from prior years will still be able to deduct them against taxable capital gains in the current year by adjusting their value to reflect the inclusion rate of the capital gains being offset. This effectively means that a capital loss realized, say, in 2023, at the current 50 per cent allowable rate will be fully available to offset an equivalent capital gain realized once the inclusion rate goes up to 66.7 per cent.

Who will be affected?

These changes are primarily aimed at high-income Canadians who regularly realize substantial capital gains in a non-registered portfolio each year, but they may also affect other people in a number of ways.

For example, consider someone who is planning to sell a secondary vacation home they inherited two decades ago from their parents. It’s conceivable that the gain on that property could be far more than $250,000, meaning that if the property is sold anytime after June 25, 2024, any gain in excess of $250,000 would now be taxed at the higher rate.

Incorporated business owners and investors who own income properties may also be affected. Some business owners who sell their qualifying small business corporation shares may be able to take advantage of the soon-to-be-enhanced lifetime capital gains exemption (LCGE), which is rising to $1.25 million as of June 25, but the excess gain (above $250,000) will now be taxable at the 66.7 per cent inclusion rate.

The same holds true for investors who own multiple rental properties and who generally won’t qualify for the LCGE. Any gains above $250,000 on the sale of an income property after June 25 will now be taxable at the higher rate.

But perhaps most significant is the potential impact the inclusion rate will have on estates. In the year of death, there’s a deemed disposition of all your capital property at fair market value. This means that if there’s a sizable non-registered investment portfolio with some accrued gains sitting there on the day you die, your estate will have to pay tax on the deemed realization at the 66.7 per cent rate for any capital gains above $250,000.

Planning opportunities

Given the pending inclusion rate change, what can you do about it?

The biggest opportunity, of course, is to realize capital gains prior to June 25, 2024. This is especially true if you hold investments, such as marketable securities, inside a corporation since the corporation won’t get a break on the first $250,000 of annual gains from June 25 onwards.

For individuals, this would only make sense if the gains you expect to realize after June 25 are in excess of $250,000 since you’ll still be able to take advantage of the 50 per cent inclusion rate post-June 25 on that amount. After June 25, individuals will need to consider whether they may wish to trigger $250,000 of capital gains annually to benefit from the 50 per cent lower inclusion rate.

Whether it makes sense to prepay the tax by realizing capital gains before June 25 is, of course, the key question. But,using the rates above for an individual Ontario investor, saving nearly nine percentage points in tax is nothing to sneeze at. On a $100,000 capital gain, that savings is $8,930, but it comes at the cost of “pre-paying” $26,760 of capital gains tax today by prematurely triggering the gain.

If you invested that $26,760 of tax in a growth portfolio earning a six per cent return, compounded annually, and taxed as a capital gain only at the end (at the new 66.7 per cent inclusion rate), it would take about eight years of tax-deferred growth to beat the $8,930 tax savings.

That sounds like a plan to me, but be sure to check with your tax adviser, as there’s also a new 2024 alternative minimum tax that could throw a wrench into your pre-June 25 planning.

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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