As discussed below, there are essentially three ways you can realize a foreign exchange (FX) gain or incur an FX loss.
Exchange of foreign currency
First, a loss or gain can occur when you sell foreign currency for Canadian currency. For example, say you bought some US dollars when the US and Canadian (C) dollars were trading at par. Later, you exchange US$10,000 of that amount back into C$11,000 when the currencies are trading at US1$ = C$1.10. That exchange will net you a foreign gain (FX gain) of C$1,000.
A special rule in the Income Tax Act provides that you must total all of your FX gains and losses from exchanges of foreign currency for the taxation year. The resulting total gain or loss for the year, net of the first $200 net gain or loss, is a capital gain or capital loss. In the above example, if you have no other FX gains or losses in the year, you would report an $800 capital gain, and half of that or $400 would be the taxable capital gain included in your income.
The exclusion of the first $200 net gain or loss alleviates record-keeping for persons who make relatively small FX gains or losses on exchanging foreign currency (e.g. you take one trip to the US this year and exchange only a few hundred dollars).
Purchase and sale of property with foreign currency
The Canadian income tax system uses Canadian dollars for reporting income, losses, tax, and all other amounts. As a result, you must always report the purchase price and sale price of property in Canadian dollars. A resulting gain or loss on the property upon its disposition may include an FX gain or loss.
You bought some US shares on a US stock exchange at a cost of US$10,000. At the time of purchase, the exchange rate was US$1 = C$1.10. Therefore, your cost of the shares in C$ was C$11,000.
You subsequently sell the shares for US$15,000. At the time of sale, the exchange rate is US$1 = C$1.20. Therefore, your sale proceeds are C$18,000 (US$15,000 x 1.20).
You will have a capital gain of C$7,000 ($18,000 − $11,000). Half of that amount will be included in your income as a taxable capital gain.
Note that of the total $7,000 gain, a portion is actually an FX gain resulting from the increase in value of the US dollar from the time of purchase to the time of sale. If the US$:C$ exchange rate had remained constant, your sale proceeds would have been only C$16,500 (US$15,000 x 1.10).
Repayment of foreign currency debt
Lastly, you can realize an FX gain or loss upon the repayment of a loan or other debt obligation denominated in foreign currency.
For these purposes, you must report the amount of the debt in C$ at the time the debt was incurred and subsequently when the debt is repaid. Any gain or loss resulting from currency fluctuation will be an FX gain or loss.
You took out a US loan of US$10,000. At the time of the loan, the exchange rate was US$1 = C$1.10. Therefore, the amount of your loan in C$ was C$11,000.
You subsequently repay the loan when the exchange rate is US$1 = C$1.20. Therefore, your repayment $ is C$12,000.
You will have a capital loss of C$1,000 ($12,000 − $11,000). Half of that amount can be claimed as an allowable capital loss.
The above discussions assume the properties and loans are capital in nature, so that the resulting gains or losses are capital gains or losses. If they were on income account, the analysis would be the same, except the full gains or losses would be reported rather than just half of the amounts, and the $200 threshold exclusion would not apply.