Capital gains earnings result when capital property, other than personal property or inventory, is sold for an amount greater than that at which it was acquired.  Think of an investment as an example.  When this type of property increases in value it will result in a capital gain. Conversely, if a taxpayer sells such property for less than their original cost of the property, they in turn have a capital loss.

When the taxpayer sells capital property which has been depreciated for more than the depreciated book value (referred to as the “undepreciated capital cost” or UCC), the amount above the UCC is included in income.  Additionally, depreciated property that sells for less than its UCC allows the taxpayer to deduct on account of income the proceeds of sale below its UCC.

The major difference between income tax and capital gains tax is that every dollar of income that one earns will be taxed.  However only half of one’s capital gain is taxed.

Capital gains tax is in place for a few important reasons. Most importantly it ensures that tax is payable no matter how one earns their money.

Most often Canadians encounter capital gains in the context of real estate transactions and investments.  And there is a very important exception to capital gains in the case of one’s principal residence.  If one were to sell their principal residence for more than they paid, although there is technically a capital gain, the “principal residence exemption” ensures that no tax is payable on the gain.  The same is not true if one were to make a gain on the sale of a rental property for example.

Given that only half of a capital gain is taxable one can see why it would be beneficial to have their income characterized as a capital gain rather than business income.  This characterization becomes a contentious issue especially in the context of investments and real estate.

With respect to investments, if one were to purchase stocks and hold them for a long time and sell them afterwards, it could easily be argued that the gain is a capital gain and that only half of the gain is taxable.  However, if somebody’s job is to trade stocks (think of a day trader for example), and they spend their time buying and selling stocks, it could easily be argued by the CRA that the profit from buying and selling of stocks is not actually a capital gain, but rather business income as the taxpayer is engaged consistently in the activity of purchasing and selling stocks.