What are capital gains and losses?
You make capital gains or losses from capital properties. The idea of a gain or loss is what you already know: you make a gain when you sell something for more than its cost, and you make a loss when you sell something for less than its cost. When it comes to capital gain or capital loss, the fundamentals are the same, but there are certain things that are a bit tricky.
Let's start with capital property. It's not just any property. Capital property is generally defined as property that provides you with a long-term benefit such as house, car, jewelry, etc. It includes things you buy for investment purposes or to earn income, such as equipment you use in a business or a rental operation, real estate, land, etc. However, it does not need to have a physical existence and therefore includes things like stocks, bonds, units in a mutual fund trust, etc. It also includes depreciable property, that is, a property that falls in value over time such as car, furniture, piano, etc. It is important to note that to be considered a capital property, things don't have to be for investment purposes only or to earn income. Household items such as furniture, etc., things you own for personal use, such as sports equipment, etc., or even valuable items that you own as a hobby such as coins, art pieces, etc., are also considered capital property.
From the above description of capital property, you can see that there are various types of capital property based on purpose or use of the property. How the Canada Revenue Agency (CRA) considers them for taxes is also different. This is why you need to understand the types so that you can do your taxes correctly. Capital property is classified into the following three types:
Personal-use property: Capital property you own for your personal use or enjoyment or for use or enjoyment by a person or beneficiary related to you. For example, car, house, furniture, cottage, boat, car, etc. This type of capital property is different from capital property that you own for generating income.
Listed personal property: Similar to personal-use property, but the difference is that properties that fall in this category generally do not depreciate. This type of capital property includes collectibles such as jewelry, coins, works of art, etc.
Other capital property: Any capital property you acquired for the purpose of earning an income. This type of capital property excludes personal-use property and listed personal property. For example, stocks, bonds, business assets, machinery and tools, partnership interest, capital investment in real estate, etc. (Note that business inventory is not considered a capital property.)
Now, what is capital gain or capital loss? We still need to get two more things out of our way before we get to that definition.
Firstly, note that capital gain or capital loss occurs when you dispose of a capital property. We didn't say "when you sell a capital property." That's because disposition can mean a variety of things: selling a property, transferring a property to someone, changing the use of a property—for example, converting your principal residence into a rental property, giving away a capital property by way of gift, etc.
Secondly, we need to explain what is proceeds of disposition and adjusted cost base.
Proceeds of disposition is what you receive from disposing a capital property.
Just like the difference between selling and disposing, proceeds of disposition could be the amount you received from selling. That is, the selling price of a property. But it could also include compensation you received from property that has been destroyed, expropriated, or stolen.
Adjusted cost base is usually the cost of the property, such as the price you paid for the property, plus your expenses to acquire it, such as commissions and legal fees that you paid.
If you received a property as a gift or through inheritance, the cost of the property is the fair market value of the property at the time you received it. Fair market value is the highest dollar value you could get for your property in an open and unrestricted market (between a willing buyer and a willing seller, who would be acting independently of each other).
Adjusted cost base also includes capital expenditures, such as the cost of additions and improvements you made to the property. You cannot add current expenses, such as maintenance and repair costs, however.
To calculate the adjusted cost base of a capital property, add the price of the property or the fair market value of the property, your expenses to acquire it, and the cost of any additions or improvements you made to it.
With all of that out of our way, the definition of capital gain or capital loss is simple:
Capital gain: when the proceeds of disposition of a capital property is more than its adjusted cost base.
Capital loss: when the proceeds of disposition of a capital property is less than its adjusted cost base.
Special note about claiming capital gains or losses on personal-use property and listed personal use property
Since you use (consume) personal-use property and it wears out, you cannot claim a capital loss from the disposition of this type of capital property. But if you make a gain, you need to report it.
Unlike personal-use property, you can claim capital loss on listed personal property. However, the loss can only be applied (claimed) against gains from the same type of capital property.