Meet Sarah
Imagine Sarah bought $40,000 worth of investments several years ago.
Today, they're worth $80,000.
She is sitting on an unrealized capital gain of $40,000.
Sarah normally earns $110,000 a year, but this year is unusual. She takes several months away from work, and her employment income falls to just $30,000.
She could leave the investment untouched.
Or she could consider selling some of it and intentionally realizing a capital gain during this lower-income year.
Why would anyone volunteer to create a tax bill?
Because in Canada, the year in which you realize a capital gain can matter.
Canada has progressive income-tax rates. As taxable income rises, additional income can be taxed at higher marginal rates. Provincial or territorial income tax also applies.
That can make an unusually low-income year an interesting tax-planning opportunity.
A $40,000 Gain Doesn't Mean $40,000 of Taxable Income
This is where capital gains are often misunderstood.
Under the current rules, generally 50% of a capital gain is included in income for tax purposes.
So if Sarah realizes a $40,000 capital gain, the taxable capital gain would generally be $20,000.
She doesn't owe $20,000 in tax.
Instead, that $20,000 enters the calculation of her income and is taxed along with her other taxable income.
In this simplified example, Sarah could have:
$30,000 in employment income
- $20,000 taxable capital gain
= roughly $50,000 before considering other income, deductions and tax adjustments.
Now imagine Sarah waits until she's earning $110,000 again.
The same $20,000 taxable capital gain could instead arrive in a year when she already has much more income.
That's why timing can matter.
Why Would Anyone Pay Tax Early?
Because "pay later" doesn't necessarily mean "pay less."
Suppose Sarah refuses to sell because she doesn't want a tax bill today.
Ten years later, she finally sells while earning substantially more income.
She has enjoyed years of tax deferral, which has real value. But she may also be realizing the gain when her marginal tax rate is higher.
Capital-gains harvesting asks a different question:
Instead of only asking, "How long can I delay this tax?" ask, "When is the most tax-efficient time to realize this gain?"
The answer isn't automatically "today." The value of continued tax deferral and investment growth must also be considered.
Sarah Doesn't Have to Sell Everything
Here's another important part of the strategy.
Sarah doesn't necessarily need to realize the entire $40,000 gain.
She could sell only part of her position and realize a smaller gain.
That allows an investor to potentially choose how much income to recognize during an unusually low-income year rather than treating the decision as all-or-nothing.
The appropriate amount would depend on other income, deductions, available capital losses, province or territory and the investor's broader financial situation.
What If Sarah Still Loves the Investment?
Selling an appreciated investment doesn't necessarily mean saying goodbye to it forever.
An investor may sell an appreciated publicly traded investment, realize the capital gain and later purchase the investment again.
The new purchase establishes a new acquisition cost that becomes relevant when calculating a future capital gain or loss.
In other words, Sarah may be able to deliberately crystallize some of her existing gain during the lower-income year.
Accurate record-keeping is essential.
Generally, a capital gain is calculated using the proceeds of disposition, minus the adjusted cost base and eligible costs associated with selling the investment.
Capital Losses Can Change the Picture
Now imagine Sarah owns another investment that hasn't performed nearly as well.
She sells it for a capital loss.
Generally, allowable capital losses can offset taxable capital gains. If Sarah ends up with a net capital loss that she cannot use in the current year, it can generally be carried back to offset taxable capital gains from the previous three years or carried forward to future years.
That creates another layer of planning.
Instead of looking at each investment separately, an investor can consider gains, losses and overall taxable income together.
There's an Important Trap With Losses
Harvesting a gain and harvesting a loss aren't exactly the same thing.
Canada has superficial-loss rules that can deny a capital loss in certain circumstances when the same or identical property is acquired within the specified period surrounding the sale and is still owned at the end of that period.
Those rules matter when an investor sells at a loss and quickly buys the same or identical investment again.
They generally aren't what prevents an investor from selling an appreciated investment, realizing a gain and buying it again.
That distinction is important.
Don't Start Selling Everything in December
Capital-gains harvesting isn't automatically beneficial.
Realizing a gain today means giving up some tax deferral. Money paid in tax now is money that can no longer remain invested and compound.
Realizing a capital gain can also increase income reported on a tax return and potentially affect income-tested benefits, credits or other tax provisions.
Existing capital losses, deductions, other sources of income and provincial or territorial tax rates