When you sell almost anything in Canada you're going to have to pay taxes on the sale. But selling a property you own comes with some unique benefits. We all know about the principal residence exemption, where you can sell your home tax free. But rental properties are capital assets, which have capital gains taxation when they're sold. Understanding how capital gains work might give you some more incentive to become a real estate investor.

Here is a simplified view of Capital Gains and Real Estate, presented to you solely for informational purposes.

What Are Capital Gains?

Let's define what capital gains are with an example. If you sell a rental property for $500,000 that you purchased for $400,000, you have $100,000 in capital gains.

So, capital gains is the difference between the purchase price and the sale price. But here's the big benefit: Unlike most sales in Canada where you pay tax on the total price of whatever you sell, capital gains tax is only applied to 50% of the capital gains.

Adjusted Cost Base

That's great in itself, but it gets better: We can tack on certain expenses onto the purchase price of the home, giving us the adjusted cost base.

So, the seller could take things like the cost of his legal fees, the cost of upgrades to the home *like if he built an addition or update to the home*, and commissions paid to the brokerage, and he can add these onto the purchase price.

If the costs for an addition, plus legal fees, plus commissions totalled $40,000, instead of $100,000 in capital gains, the adjusted cost base would reduce that number to $60,000 in capital gains. And since only 50% of capital gains are taxable, you would only be paying federal and provincial tax on $30,000 on the gain, since capital gains taxed as part of your income.

In Ontario, we have a progressive tax system. Income is taxed in different ranges and different rates, applied both provincially and federally. How much you pay end up paying in tax on your capital gains largely depends on your income with the capital gains added on.

Capital gains are actually the lowest taxed source of income in Canada, which is just one of the many reasons why real estate is such an awesome investment.