Something pretty can be made to look ugly, only to be made prettier again.
At the core, a capital gain is a very beautiful thing. Dealing with a gain means that something could be a stock, a piece of real estate, art, or even a bar of gold amongst other things, and was sold for more than it was paid for. These transactions are the ones that make money when it comes to investing, and this is generally the goal. People tend to view this beautiful thing through a lens that makes it appear less attractive. The only thing that could be responsible for such a crime is, tax.
A simple example to illustrate the capital gain in action would be that an investment of $10,000 was made in a stock and then sometime later, in any given time frame, it was worth more, say $20,000. At this point, the gain is considered unrealized for the simple reason that the stock is yet to be sold.
Unrealized gains accumulate on a tax deferred basis until the investment is sold, at which point the gain is considered realized.
If the stock was sold at $20,000, then the gain would be realized at $10,000; the difference between $20,000 and $10,000. In terms of taxation, only 50% of capital gains are taxable. In this case, $5,000, which is 50% of the $10,000 gain, would be taxable and assuming a 40% tax bracket, $2,000 in income tax would be owed. Not surprisingly, this part, the ugly part, is what attracts most of the attention.
It’s important to remember that if $10,000 of income was earned, which could have come in the form of earned income (salary), interest, rent or pension income, all of it would be taxable. $10,000 of income in the same 40% tax bracket, results in $4,000 of tax.
The two advantages of capital gains have just been highlighted:
- Only 50% of the gain is taxable, and
- They accumulate tax deferred.
On a side note, if the gain was realized in either a TFSA, RRSP or other tax-sheltered plan, the realized gain would not attract any tax. The only gains worth worrying about are those that occur in a Non-Registered, which is also known as a cash or investment account.
A capital loss, the flip side of a capital gain, is realized when an investment was sold in a Non-Registered account for less than the original purchase price.
For example, an investment of $20,000 was made and then some time later, the stock was sold for $10,000; the result is a $10,000 capital loss. Fortunately, this ugly thing can be made to look more attractive.
Capital losses can be used to offset capital gains that were triggered up to three years in the past, they can also be carried forward indefinitely.
If the $10,000 gain described above was offset by a $10,000 loss, the two transactions offset each other; no tax is owed. If taxes have been filed properly, then, all available capital losses will be listed on the most recent Notice of Assessment for income tax purposes.
Also noted on the Notice of Assessment is the RRSP contribution room available to be used during the year. If there are no available losses, then making an RRSP contribution can be used to offset realized capital gains. For example, if there’s a $10,000 capital gain on hand, there will be a $5,000 increase in income. To offset that income, a $5,000 RRSP contribution can be made and then no additional tax will have to be paid. An important thing to note here is, that any money leaving an RRSP is 100% taxable, so this is in effect kicking the can down the road. But down the road may be more of a favorable time to pick the can up as your taxable income may not be as high.
When it comes to investing, letting the tax tail wag the head of the dog is generally not a good idea.
Certainly, doing what’s possible to pay less tax is never a bad idea, but not selling an investment that should be sold because it will require some tax to be paid is a very bad idea.
A true story, highlights this lesson.
Towards the end of the 90’s an investor made a very wise decision by making a significant investment in Ballard Power Systems. Investors couldn’t get enough of Ballard, but unbeknownst to them the floor was about to fall out from underneath, as was the case with many companies; it was the tail end of the tech bubble. The investor chose not to sell Ballard because the result would’ve been a massive tax bill; the result of a $1m capital gain. At the peak, Ballard was trading at around $165 per share and today, December 1st 2017, it closed at $6.11.
Contact us for more information on how to make something ugly look prettier and how to not let a beautiful thing turn ugly.
Mike Preto and Jason Del Vicario are Investment Advisors at HollisWealth, a division of Industrial Alliance Securities Inc. Based in Vancouver, BC, Canada, they work together in bringing a unique approach to managing money to ensure their clients are financially prepared for their retirement. They can be reached at 604-895-3349.
This information has been prepared by Mike Preto & Jason Del Vicario who are Investment Advisors for HollisWealth®. The opinions expressed in this article are those of Mike & Jason only and do not necessarily reflect those of HollisWealth. HollisWealth® is a division of Industrial Alliance Securities Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. Hillside Wealth Management is a personal trade name of Mike & Jason.