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The looming tax harvest


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This is more a question for my Canadian friends as the tax situation in US tends to be less severe or at least it can be more difficult to raise taxes across the board

 

The post Covid world may see

1) capital gains inclusion go way up.  75 to 100%

2) principal resident exception on home possibly go away

 

Wondering how some of you are approaching this issues especially with regard to large capital gains you may have in stocks held for many years?

 

I see financial advisors telling people to trigger gains now before it’s too late but killing the compounding machine also has its drawbacks?

 

So far I have stayed with benign neglect of the portfolio but wondering if I am a sitting duck especially with some of the large capital gains made over last 10 years

 

Thanks

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This topic worries me, too. Both for equities and real estate investment.

 

What I'd like to think... get some more cash ready. Especially on the real estate side. I think the combination of increased capital gains inclusion and the principal resident being taxed would lead to a short-term crash in the market. But I'm not selling my condos during the fire sales as they are in quality locations. Instead, I'd look to take advantage of downturns.

 

So instead of thinking of selling, think of it as another opportunity to accumulate your assets at cheaper prices...

 

EDIT: I realize that my advice is more for younger people like myself who should be building assets. If you are closer or in the retirement age, I think the thinking/action would be different.

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Strong possibility that going forward, the capital gains inclusion is tied to length of holding period. Arguably > 50% if the gain/loss is from short term trading, < 50% if the hold period is >'n' years. Estate transfers grandfathered at pre-change rules.

 

Lot of people made 100%+ gains earlier this year when the Dow was swinging 2,000 points/day, and have just done it again with the vaccine announcements - a lot of people also have sizeable UNREALIZED losses. Better to let sleeping dogs lie, and NOT trigger mass sales; creating a net LOSS refunded at 50%+

 

The principal residence exemption is not going to be retroactively taken away, at worst the minimum residency time might be increased to 1 year or more. Going forward it's always a possibility but politicians still need to get elected, and there is little benefit to playing with live wires.

 

WWII brought in a lot of 'temporary' changes to pay for the war effort, so expect creative fund raising efforts.

Our own thoughts are 100% domestic, long term, tax free Covid bonds, with minimum holding periods and 100% inflation linked interest payments. Minimum hold of 5-10 yrs, so that they trade as medium term notes. Long term so that investors can keep the tax free status for as long as possible. Raise CAD 100B+ (fed + provinces) in successive financing rounds, and there is less need to risk messing with tax rates.

 

SD

 

 

 

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I think that there's zero chance that the principal home exemption will go away.

 

I'm also pretty sure that the capital gains inclusion goes to 100%. Maybe it goes to 75%, maybe not. Even if it does it probably won't be implemented overnight so you'll have time to crystalize capital gains at the lower inclusion rate.

 

I think it's dangerous to think in terms of how the op framed the issue. I've seen quite a few people do dumb tax things because they always think that the tax boogeyman is right around the corner when in reality there's no one around the corner. Generally the best tax strategy always is defer, defer, defer.

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1) capital gains inclusion go way up.  75 to 100%

 

I don't think it will happen unless the US raises capital gains taxes significantly. 

 

Capital is fungible and flows easily across borders.  That's different from labor which can't easily cross borders.  Canada already has a problem with low investment levels and its main competition for capital is south of the border. 

 

When President Clinton cut the US capital gains tax rate to 20% in 1998, it's no coincidence that Canada had to reluctantly follow a few years later (cutting the inclusion rate from 75% to 67% to 50% in 2000).  Prior to that, the combined Federal/Ontario cap gains tax rate at the top marginal tax rate was almost 40%.  That was a plainly unsustainable 20% delta versus the US rate and thus was cut to a mid-to-low 20% top rate in Canada for much of the aughts.

 

Canada can't afford to create a sizeable gap (current top cap gains tax rate in Ontario = 26.76%) vs the US capital gains tax rate (23.8% including Obamacare net investment income tax).  Moving the inclusion to 75% - 100% would raise the cap gain tax rates in Canada to 40-53%. 

 

With potentially a divided US government and gridlock for the next four years, its unlikely that the US will be raising tax rates much, if any.  There's no way that Canada could afford to open up a 20%+ gap again in how capital is taxed in Canada vs the United States.  Much of the chatter about Canada raising inclusion rates was maybe predicated on large tax increases in the US when it looked like a Democrat control of Congress and the Executive Branch.  That's unlikely now with Senate control likely in Republican hands.

 

I wouldn't lose any sleep over it.  It's not happening.  And if a Federal government tried to do it, it would be quickly reversed after a few years.  They might tinker a bit, but there won't be any big moves.

 

wabuffo

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Wabuffo excuse my ignorance but I hear this argument often and don’t totally understand it

 

How easily can we really move capital to US markets from Canada ?  What is the mechanism?

 

As a Canadian I don’t see how I can simply start investing in US equity and get the lower capital gain tax unless you mean people with capital are just going to leave Canada and become US citizens to get the lower capital gains tax ?    I suppose that is the obvious mechanism for the flight of capital argument

 

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The Cdn investment is put up as collateral against a loan, with loan proceeds invested in the US. No sales, no tax triggers, no issues. Blows up if there is a sudden drop in the value of the collateral, so most would over collateralize.

 

SD

 

But then why doesn’t everyone just do this with Switzerland.  A country with zero capital gains tax ?

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The Cdn investment is put up as collateral against a loan, with loan proceeds invested in the US. No sales, no tax triggers, no issues. Blows up if there is a sudden drop in the value of the collateral, so most would over collateralize.

 

SD

 

But then why doesn’t everyone just do this with Switzerland.  A country with zero capital gains tax ?

 

Lots of places with zero capital gains tax, but most require you to either be a citizen or resident there.

Ultimately You will pay, but it'll just be in other ways. EVERYBODY pays, even the Swiss.

 

SD

 

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The Cdn investment is put up as collateral against a loan, with loan proceeds invested in the US. No sales, no tax triggers, no issues. Blows up if there is a sudden drop in the value of the collateral, so most would over collateralize.

 

SD

 

But then why doesn’t everyone just do this with Switzerland.  A country with zero capital gains tax ?

What you say is not correct. It's not true that Switzerland has a zero capital gains tax. What's true is that Switzerland doesn't have a capital gains tax. The reason why Switzerland doesn't have a capital gains tax is because capital gains have a 100% inclusion rate and are taxed as ordinary income. In addition Switzerland levies a wealth tax on your net assets.

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The Cdn investment is put up as collateral against a loan, with loan proceeds invested in the US. No sales, no tax triggers, no issues. Blows up if there is a sudden drop in the value of the collateral, so most would over collateralize.

 

SD

 

But then why doesn’t everyone just do this with Switzerland.  A country with zero capital gains tax ?

What you say is not correct. It's not true that Switzerland has a zero capital gains tax. What's true is that Switzerland doesn't have a capital gains tax. The reason why Switzerland doesn't have a capital gains tax is because capital gains have a 100% inclusion rate and are taxed as ordinary income. In addition Switzerland levies a wealth tax on your net assets.

 

Thanks for clarifying

I guess not to leave the main point    I’m just trying to understand the issue of “flight of capital “.  In other words why do we have to keep our capital gains policy similar to US and if capital can easily flee then any other country with low capital gains taxes would just reap the benefits even if US and Canada both raised rates.   

Just trying to understand these issues from those here that are more knowledgeable

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The Cdn investment is put up as collateral against a loan, with loan proceeds invested in the US. No sales, no tax triggers, no issues. Blows up if there is a sudden drop in the value of the collateral, so most would over collateralize.

 

SD

 

But then why doesn’t everyone just do this with Switzerland.  A country with zero capital gains tax ?

What you say is not correct. It's not true that Switzerland has a zero capital gains tax. What's true is that Switzerland doesn't have a capital gains tax. The reason why Switzerland doesn't have a capital gains tax is because capital gains have a 100% inclusion rate and are taxed as ordinary income. In addition Switzerland levies a wealth tax on your net assets.

 

Thanks for clarifying

I guess not to leave the main point    I’m just trying to understand the issue of “flight of capital “.  In other words why do we have to keep our capital gains policy similar to US and if capital can easily flee then any other country with low capital gains taxes would just reap the benefits even if US and Canada both raised rates.   

Just trying to understand these issues from those here that are more knowledgeable

Yea I'm with you. I disagree that a divergence in the capital gains inclusion would have much effect of capital or its flight.

 

Generally capital flight is used in reference to primary market capital. Think money to build factories. Not secondary market capital like your Procter and Gamble shares which is what you're referring to. However whenever the discussion starts there will be a lot of rhetoric that will equate the former to the latter.

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It's really the difference in net tax (after every possible deduction) that matters, and the remaining # of years over which you expect to pay. To get the lower rates you have to jump a lot of hoops, and both the annual and cumulative difference has to be enough to make it worthwhile.

 

Assume a choice between the US (assume 35% tax) and BVI (25% duties).

https://www.investopedia.com/ask/answers/100215/why-cayman-islands-considered-tax-haven.asp

 

10% on 1M is 100K saved, against which there are the incremental costs of living in BVI vs the US (assume 35K/yr). Are you really going to move to BVI to just save 65K/yr (6.5% on the 1M) in taxes? Probably not, 'cause frankly - you just don't earn enough! But what if you earn 10M/yr, and spend an incremental 100K/yr vs 35K? Moving to BVI now saves you 900K/yr (9% on the 10M) in taxes, and you will live a very nice life.

 

Easy for companies to move (primary capital), not so much for people (secondary capital).

Hence there can be some 'lag' in making tax rate adjustments.

 

SD

 

 

 

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Even if it does it probably won't be implemented overnight so you'll have time to crystalize capital gains at the lower inclusion rate.

 

If the inclusion rate is increased, I don't consider this the highest probability scenario. To my recollection, when the capital gains rate changed in the past, the rate change typically took effect the day after the budget was released, not the day the budget bill was approved through royal asset.

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Even if it does it probably won't be implemented overnight so you'll have time to crystalize capital gains at the lower inclusion rate.

 

If the inclusion rate is increased, I don't consider this the highest probability scenario. To my recollection, when the capital gains rate changed in the past, the rate change typically took effect the day after the budget was released, not the day the budget bill was approved through royal asset.

 

 

Yes, by my memory that's true.  It was the elimination of the $100k Lifetime Capital Gains Exemption in roughly 1994 which had an implementation period.  People cashed out their winners to max out their gains before the measure hit the sunset date.  Is it a good policy approach or a bad policy approach to give people a transition period?  If you cannot have predictability is a "fair" transition a second best?

 

 

SJ

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Even if it does it probably won't be implemented overnight so you'll have time to crystalize capital gains at the lower inclusion rate.

 

If the inclusion rate is increased, I don't consider this the highest probability scenario. To my recollection, when the capital gains rate changed in the past, the rate change typically took effect the day after the budget was released, not the day the budget bill was approved through royal asset.

Yeah, but generally those inclusion rate was changed downward. Doesn't hurt anyone. I'm not nearly old enough to remember when the inclusion rate went up. So sorry about that.

 

Even the socialist in me thinks it would be unfair to have an immediate effect. The pro argument would be that it would avoid chaos as ppl scramble to reset their ACB. The really unfair bit is that capital gains are cumulative so you would tax my gain 2015 which had a 50% inclusion at a 75% inclusion. I just don't think that anyone wants that particular brand of shit storm. Not for capital gains inclusion rate.

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The other pro of waiting for a bit to raise the inclusion rate (aside from the fairness argument) is that it would generate tons of current year tax revenue.

 

If they up the inclusion rate I would probably sell some long-held multi-baggers to lock in the lower rate on previous gains. I would also try and sell some real estate for the same reason, although that would depend how much time they gave.

 

Tons of people would do the same, triggering a one-year tax windfall.

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The other pro of waiting for a bit to raise the inclusion rate (aside from the fairness argument) is that it would generate tons of current year tax revenue.

 

If they up the inclusion rate I would probably sell some long-held multi-baggers to lock in the lower rate on previous gains. I would also try and sell some real estate for the same reason, although that would depend how much time they gave.

 

Tons of people would do the same, triggering a one-year tax windfall.

I would think that the real estate would be tricky. Depends on how you handled the depreciation. Triggering a whole bunch of recapture may not be such a good thing.

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Unfortunately Canada is one of the few countries in the world with an exit tax at all and of those that have it , it kicks in at a paltry 100k canadian. As such they have locked the doors while starting the fire. It is crucial if you have capital to move residency before you are rich or before you invest. Or..alternatively when there is a crash. 2020 was an excellent year to take up residency in Europe , for example if you have an EU passport or take advantage of one of their programs. 1/3 of the EU countries have zero or very low capital gains tax in one form or another. The key is to do it before. And I see a high chance Canada is going to be desperate and go for confiscation

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