Tax planning is about more than claiming deductions and filing tax returns. Ever since the invention of capital gains and losses, shrewd investors have been using the sale of stock to mitigate their tax hit. How does that work? Todd Sigurdson, IG Wealth Management’s director of tax and estate planning, explains.
Investors first need to understand the fundamentals of capital gains and losses. For one, capital gains only become taxable when a profitable investment is sold.
How gains work
Investors first need to understand the fundamentals of capital gains and losses, says Sigurdson. For one, capital gains only become taxable when a profitable investment is sold. Moreover, tax is triggered only when you sell an investment held in a taxable account. In other words, capital gains and losses do not apply when you sell a profitable asset inside an RRSP, TFSA or RESP. Additionally, when you do sell a profitable asset, only half of the gain is taxable.
Take advantage of losses
While realized gains are taxable, selling investments worth less than what you paid for them results in a capital loss. This is important, especially from a tax perspective. A realized capital loss can be applied against realized capital gains – and, therefore, reduces the amount of tax you’d have to pay on that gain, says Sigurdson. For example, if you sell stock on which you earned $100, and you have a stock that lost $50, you could sell the poor performing investment and use that loss to cut your taxable gain in half.
No gains, no problem
Capital losses can only offset capital gain – they can’t be applied against dividends, interest or employment income – except in one situation. When you die, your estate can claim net losses on investments against any taxable income in both the year of death and the preceding year. For those still living, net losses can be applied retroactively, to capital gains that were realized in the three previous years. So, if you paid capital gain taxes on the sale of a mutual fund in 2015, you could sell an underperforming investment in 2018, claim the loss and amend your 2015 tax return resulting in reduced tax for that year, says Sigurdson. Additionally, losses can be carried forward indefinitely and used to reduce future capital gains.
Transferring real estate-related gains
Stocks held in registered accounts aren’t the only assets exempt from capital gains. So too are gains made off the sale of a home through the principal residence exemption. What many people don’t know, though, is that this exemption, which can only be used on one piece of property, can be transferred to other real estate assets. For instance, if your cabin appreciates in value faster than your home you may want to use the exemption on the cottage if you plan to sell it, says Sigurdson. Once the exemption is used, though, your home is now subject to taxation upon sale.
Donate stocks and save on tax
Giving investments in-kind to a charity can eliminate capital gains taxes entirely. This is a better strategy than selling the investments, paying taxes on gains and then making the cash donation to get the tax credit. “So rather than selling a $5,000 mutual fund with a $2,000 gain, and paying as much as $500 in taxes, you donate in-kind to a charity, save $500 in taxes, and receive the tax credit for a $5,000 donation,” he says.
Whatever you do, don’t make the mistake of forgetting to include capital gains and losses in your tax plan. It’s not the most obvious tax-saving tool, but it’s one that can save you a lot of money come tax time.