Capital Gains Harvesting In A Personal Taxable Account

Capital gains harvesting is the process of realizing some capital gains on an investment and then immediately buying it back again to stay invested. It basically triggers some tax now instead of later. I previously wrote about how capital gains harvesting in a corporate account can be a sound strategy to flow money out of a CCPC at an overall lower tax-rate. In contrast, capital gains harvesting in a personal non-registered (taxable/margin) account is much more of a gamble. While deferral of realizing capital gains to defer tax is generally advisable, there are times where it may be beneficial. Is this one of those unusual times?

What is capital gains harvesting vs tax loss selling?

Most people think of capital loss harvesting or “tax-loss selling” when they think of strategically realizing capital gains/losses. The concept is to realize some capital losses and then re-buy a similar stock or ETF. That allows you to stay invested, but use that loss to offset capital gains from other holdings that you sell. It essentially defers the tax. Because of that potential for a tax-payer to benefit, there is a superficial loss rule that you cannot re-buy the identical stock or ETF within a 30-day window on either side of the realized loss.

Capital gains harvesting is basically the opposite process and is not frequently discussed. You sell a holding with a capital gain and immediately re-buy it. The reason that it is rarely discussed is because paying tax now rather than later is generally a bad move. It shrinks the amount of capital you have invested to benefit from the magic of compound growth. Harvesting capital gains results in you paying tax now, but also resetting the adjusted cost base of the investment (so that there will be less capital gains to be taxed in the future).

realizing capital gain

There are some situations where capital gains harvesting may actually reduce the tax paid. One is in a corporation as a way to pay out tax-free capital dividends to meet a cashflow need. The other situation is more of a gamble on current tax rates vs future tax rates.

What are you betting on when you harvest capital gains in a personal taxable investment account?

The basic premise behind a successful capital gains harvest in a personal account is that you will pay a smaller amount of tax now than in the future. It also hinges on when that happens. Taking a tax-hit now reduces the invested capital that grows. If would otherwise be growing for a short period before being accessed and taxed, then that early tax-hit has less of an impact compared to a long time-frame where compound returns dominate. What does that mean in practical terms?

If you think there is going to be a big tax jump between now and when you would normally realize the gains in the future, then it favors a harvest. The shorter the time before you would be accessing the money, the more it favors a harvest. It is a gamble on tax rate and time. Anyone who gambles is taking a risk. Risk and reward are usually tightly linked. However, we can take an educated gamble that may tilt the tables in our favor. To do that, we need to understand how capital gains are taxed.

Taxation of Capital Gains

Taxation of capital gains has always been controversial.

Rational taxation of income collects revenue based on the spending power from the income. That requires two things. The asset must grow at more than the rate of inflation to give you increased spending power. Inflation is variable and unpredictable. The asset must also be sold to access the cash value to spend it – unless you are bartering. Someone can own a Loonie Doctor house, but they can’t buy groceries with it.

Risking capital to grow a business is also how we make progress. If no one puts their money on the line to open a restaurant, then no one has a job working in that restaurant. If people or companies don’t risk capital to see if an innovative idea works, then there won’t be that innovation. The failure rate of start-up businesses in Canada is about 50% at five years. That is a major risk and you need favourable taxation to entice people to take it. If people aren’t enticed to risk capital, not only are their fewer jobs, there is less innovation.

So, capital gains should be favorably taxed to foster economic growth and innovation. It should also be delayed to tax spendable income rather than inflationary growth or non-spendable assets. The question is – how much?

Capital Gains Inclusion Rate & Personal Tax Rate

Due to the above issues, only part of capital gains are taxed and it only happens with the asset is sold (the gain is realized). The proportion of a capital gain that is taxed is called the capital gains inclusion rate. The capital gains inclusion rate is currently 50%. That portion is then taxed at the usual income tax rate.

capital gains tax increase

In using a capital gains harvest, you are betting that either the capital gains inclusion rate and/or your personal marginal tax rate will be much lower now compared to when you’d normally realize the gain.

What are the odds that the capital gains inclusion rate will rise?

No one knows the future. However, we can make educated guesses. Personally, I believe that the inclusion rate will rise either with the next Federal budget (end of Feb or March supposedly) or in the next few years. I base that opinion on history and the current government track record.

Historical capital gains tax rates in Canada.

The capital gains inclusion rate was first introduced in 1972 by Prime Minister Trudeau, The First of His Name. It was started at 50%, but rose to 67% in the late 1980s and ballooned to 75% by 1990. The rapid increases were to help dig Canada out of a deep hole of deficits. In 2000, it dropped back down to 50% when the federal budget was balanced. So, we have been higher than we are currently before. It was done to help address severe budget deficits and to get control of spirally debt from the first Trudeau governments. Sound familiar?

Why taxes will go up.

Tax experts have been warning that the inclusion rate will likely rise for the last few years as it has become apparent that budgets don’t actually balance themselves. Now, with Covid-19, we are facing the largest deficit since.. well.. ever! The Federal Government has been changing their “fiscal-anchors” as they blew past them the last few years leading up to the crisis. Now, they aren’t even pretending to have one. This isn’t a debate about how the money was needed for the Covid response (it was) nor whether it was appropriately targeted and administered. These are simply the numbers. Facts. Another fact – today’s deficits are tomorrow’s taxes.

Canada tax increase

Why the capital gains inclusion rate is a likely target.

To build assets requires a combination of saving money and then risking it on an investment. The current governing party has already used the notion that only rich people can save enough money to do that. So, it is just a tax on the wealthy. The truth is that many not-so-high-income people would also get hosed. However, that requires more thoughtful analysis. Political targets are simple and the Liberal government already successfully used that only-the-rich-invest narrative when they reduced the TFSA limits. I actually think that only those who live beneath their means and are financially literate invest. That describes the household I grew up in – that was not above the average Canadian household income. TFSAs actually benefit those with the lower incomes more than those with higher incomes – if they save and invest. RRSPs disproportionately benefit those with high incomes, but are also familiar to the average voter. So, they are hard to touch. That analysis requires a deeper understanding of how those tax shelters work. In contrast, successful political messages are simple. That beats logic.

It will be easy to spin it as “only rich people will be affected by capital gains taxes”. Yes, the wealthy will disproportionately be affected, but so will those average income folks who sacrificed to save and invest for their retirements. The Liberals didn’t care about that with the TFSA, and they likely won’t now. Further, the NDP actually had raising the inclusion rate to 75% as part of their election platform. They currently hold the balance of power and it would be easy for the Liberals to pass this and blame it on the NDP.

Increasing the capital gains inclusion rate is also a simple way to attenuate the advantages of difficult to target legal tax strategies – like capital surplus stripping and corporate class funds.

What are the odds that your marginal tax rate will rise?

The included half of capital gains is subjected to your personal marginal tax rates. So, even if the inclusion rate stays unchanged, a higher future marginal rate would increase the tax load on capital gains. There are two ways that this could happen. One is that marginal rates are raised. There is talk of this in the higher income ranges, but no one really knows. However, there are also times where we can predict that our marginal rate will change. Basically, if our income changes.

If you think that 2020 is going to be an unusually low-income year, then it may be a time to harvest. Incomes may be lower due to various natural disasters. Like Covid-19. Sick leaves. Having babies. Mid-life crises and “finding yourself”. Lots of time-limited reasons for a temporary income drop.

You may also anticipate a major income jump in the future. That could be due to growth of your business, starting a new job, or getting a promotion. In the distant future, it could also be that you build a portfolio large enough that it produces significant annual income.

If considering a change in marginal rate as a reason to capital gains harvest, it is important to remember that harvesting can bump you up marginal rates in the present. That means knowing when they take off. For example, in Ontario, rates really take off as you move >100K and again when >$215K. The risk of a harvest turning out to be a bad move rises if your current income is in the ranges where marginal tax rates hike. For example, going from 93K to 110K means a 9.5% marginal tax rate increase. Conversely, a change in income from 152K to 216K would not bump you into a higher marginal tax rate.

marginal tax brackets

What about losing capital now to taxes and missing that compounding growth?

For a capital gains harvest to be beneficial there must be a lower tax rate now than in the future. Most of us would bet that taxes will be higher in the future. However, there is another variable in the game. The rate of return. By taking a tax hit now, we reduce our invested capital. That means less to compound grow over time. If the timeframe is long and/or the rate of return is high, then it harms the strategy.

Don’t harvest money you won’t need in the next few years.

I will illustrate with an example. Let’s say our Ontario investor has a taxable income of $160K (at the low end of a wide tax-bracket – so not a big deal for getting bumped up). They have $20K invested that has grown to $30K – a $10K unrealized gain. It is compounding at a rate of 6%/yr. They are planning to use that money in 3 years and think that the capital gains inclusion rate will rise from 50% to 75% between now and then. They are betting on the left-side of the graphic below and would save about $900 in tax.

capital gains tax strategy

As you can see above, if one were going to harvest the money in the near future and the capital gains rate jumps – there is an after-tax advantage. The tax savings outweighs the lost growth. Conversely, if they weren’t going to use those funds for 20 years (the chart on the right), then they would actually reduce their final after-tax nest egg by harvesting early. The loss of compounded growth over that long time frame is worse than the higher future tax rate. The break even point in the above example is 9-10 years (where the red line crosses $0 on the chart in the bottom right of the graphic).

A larger rate of return accentuates the problem of losing capital now to taxes.

Let’s use the above example, but change the rate of return from 6%/yr to 15%/yr. An unusually high growth rate, but illustrative. The break even point shifts to 4-5 years from 9-10 years (the golden circle in the chart below). You would have to need the money in the next 4 years for a harvest to be beneficial. It is hard to make up for the upfront tax hit shrinking capital that could otherwise grow rapidly. The amount of money at stake also becomes larger given the potential for growth (note the different scales on the left).

capital gains tax planning

Should you be considering a capital gains harvest from your personal taxable account?

You may be asking yourself that question. The answer depends on whether you think that your taxes will rise – the capital gains inclusion rate and/or your personal rate. It depends on how far into the future you would otherwise be selling to access the cash (realistically the next few years). Your future investment growth rate also has an impact. Those are a lot of variables.

I am not qualified to give specific investing or tax advice. However, I am a certified Excel Nerd and have created a calculator to illustrate the potential affects of capital gains harvesting. You can click the image below to try it out.

capital gains tax planning

You can plug in your own numbers and assumptions to consider whether it may be a worthwhile gamble for you. The calculator is for illustrative and entertainment purposes, but may be useful for starting a conversation with your financial professional. Or you can talk to yourself, if a DIYer. Like me. Then again, I am also a bit Loonie and talk to myself frequently anyway.


  1. I appreciate this post very much.

    I am definitely concerned about this very topic and your calculator is immensely helpful in calculating whether it makes sense to do this now.

    Given my long time horizon, it is advisable to ride this out as I don’t need the money until 2032.

    Thank you for this!

  2. Thanks for another great post, LD! If the inclusion rate is increased, would this apply to corporately held accounts as well? Presumably the government would not at this time want to penalize small businesses. That said, the idea of tax integration should mean the inclusion rate should affect individuals equally at the end of the day, whether the gain was realized in the corp or personally. Can you clarify?

    How come your post addresses personal accounts specifically rather than all non-registered (i.e. CCPC held) accounts?

    1. Hi DJ. It would almost certainly apply equally across the board and be effective from the time it is announced (even before legislation is passed).

      I excluded CCPC from this post because I looked at that in detail here.

  3. Thanks for this! One additional point: if you’re in an equity position which you will definitely close/end this year sometime, it makes a lot of sense to pre-emptively harvest just before the budget announcement. In fact, as long as you plan to exit a winning position before your 2021 taxes are due, I think it makes sense to harvest pre-budget.

    Now, here’s one question… what if:
    * You buy something Jan 1, and it does quite nicely;
    * you harvest March 14th with a gain of $10,000 at our current inclusion rate of 50%, immediately rebuying;
    * March 15th they announce a 75% inclusion rate effective immediately; and
    * Dec 1st you finally exit the position with the price back down to where you originally bought it in January (ie $10,000 below where you sold in March).

    Do you book a $5,000 taxable gain for March against a $7,500 loss in December?

    Thank you for all your thinking and writing!

    1. Hey TN. Definitely agree with harvesting sooner if you plan to do it later this year anyway.

      The settlement date will likely be what matters for a transaction. I have been thinking on your question about harvesting winners pre-budget and losers post an inclusion rate increase. Not sure how it would work, but I can’t imagine them allowing that kind of potential advantage. They may say something like gains will have an inclusion of 0.75 or whatever, but losses applied against gains from pre-budget only count at 0.50. Not totally fair, but that could happen I think.

  4. Thanks for the response! I went digging and found the bit in the 2000 budget where the inclusion rate was changed. It doesn’t look like there was any real provision for this scenario (though the superficial loss rule would’ve made it difficult to take advantage of it directly, since the inclusion rate was dropping). Having said that, it does point to saying don’t sell any stinkers until the end of the year! has the details, page 305.

  5. Hi,

    Thanks for the post. If the inclusion rate increases will not the government include only 50% of gains for gains made before the day the new rate kicks in? and calculate the inclusion at new % for gains after? It will be a wasteful economic activity just to sell and buy just because inclusion rates increase

    1. Hi Ram. No one knows exactly how they would implement. However, in the past, it has been simply the full gain at the applicable inclusion rate at the time when gains are realized. So, could be an increase to 75% from 50% on the full gain. It would be very difficult to divide up unrealized gains into before/after and apply that at some point when realized. Of course, anything is possible.

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