Much of what made 2017 a profitable year for equity investors came from capital gains. While a healthy dividend is an attractive feature in a stock, it's the increase in value that makes the big money -- which was the case in 2017. As some stocks, mutual funds and exchange-traded funds soared to double-digit gains, many investors took their profits. As always, a portion of those winnings must be shared with the government through capital-gains taxation.
Fortunately, the tax knife doesn't cut as deeply into capital gains as it does for most other types of income. Only one-half of gains realized on the sale of a security or other capital asset is taxable.
Capital gains are subject to tax only when they are realized -- when a capital asset is actually sold. So-called paper gains -- such as when a stock or fund you own is worth more than what you paid for it -- are not included in your income. A capital gain must be reported on your tax return for the year in which it was realized.
Note that these rules apply only to taxable accounts, not to assets held within a registered account such as an RRSP, RRIF or TFSA -- in which case you do not report capital gains or other investment income within the account.
To calculate a capital gain on a security that you've sold, first determine the adjusted cost base (ACB). This is the price you originally paid for it, plus acquisition costs such as sales commissions. Subtract the ACB from the net proceeds of the sale, which is the price you sold the security for, minus any commission or other costs of disposing of the investment.
If you hold a fee-based account rather than one that charges sales commissions, the ACB and disposition value would not be affected by trading costs. But you can deduct the cost of such fees as an investment carrying charge elsewhere on your tax return.
When calculating the gain from the sale of a bond or other marketable fixed-income security, be sure not to include the amount of any interest paid to you, since this income will have been reported on a T5 information slip (Relevé 3 for Quebec residents) and taxed separately as interest income. The gain generally is based only on the difference between what you paid for the bond and what you sold it for.
Using capital losses
Capital losses realized from the sale of an asset can be used to reduce a capital gain. A loss can be applied against gains realized in the same year -- or saved for use in a future year. Alternatively, they can be retroactively applied against gains realized during the previous three years. A capital loss can be used only to reduce taxable capital gains, not other types of income such as interest, dividends or employment.
If you have an unused capital loss from many years ago, take note that the amount of the loss that can be claimed must be based on the capital-gains inclusion rate that was in force for the year the loss was realized. Capital-gains taxation was introduced in 1972, at which point one-half of gains (based on the market value at the beginning of that year) were taxable. For 1988-89, the inclusion rate was raised to two-thirds, and to three-quarters in 1990-1999. A special formula was in place for 2000, after which the rate was put back to the original one-half.
How to calculate gains and losses
Taxable capital gain and loss amounts generally are not provided on government-prescribed information slips. An exception is capital gains earned within a mutual fund you own and paid to you each year as a distribution, which is reported on a T3 (Relevé 16) or T5 slip (Relevé 3).
For your own transactions, you or your advisor will have to refer to your portfolio records to produce the necessary information, which then is reported on Schedule 3 of your federal tax return (Schedule G on the Quebec return).
Many investment dealers will send you a T5008 report (Statement of Securities Transactions), which will include the proceeds from a sale as well as the investment's book value (price at acquisition). In the absence of a T5008, the investment dealer's annual portfolio statement should provide the same information. In any event, you still will have to calculate the correct amount of a specific gain or loss.
For example, say you sold shares of XYZ Inc. for $10,000, double the $5,000 you paid for them five years ago. If your brokerage commission on the purchase was $150, your ACB is $5,150. If the commission on the sale was $250, your net gain is reduced to $4,600, of which $2,300 is taxable. At a marginal tax rate of, say, 45%, your tax bill would be $1,035, meaning you would pocket a profit of $3,565 after tax.
For shares of the same security acquired at different times, you would have had to keep an updated record of the investment's ACB as it evolved following additional purchases and sales.
Reporting mutual-fund gains and losses
When you sell units of a mutual fund held in your non-registered account, you realize a capital gain or loss. As with other securities, the amount of any commission or fees charged when the investment was purchased will increase your ACB. Similarly, the cost of selling -- such as a deferred sales charge (DSC) -- can be deducted from the proceeds.
Until recently, shares of corporate-class funds were not taxed when you switched between share classes within the corporate-class structure, resulting in a tax deferral until you redeemed shares for cash. At this point you realized a capital gain or loss. However, the 2016 federal budget eliminated this tax deferral, effective Jan. 1, 2017. Starting with the 2017 tax year, switches between corporate-class share classes are now taxed in the year they occur.
You may receive return-of-capital (ROC) income from a mutual fund (reported on a T3 slip), such as when a targeted annual distribution level could not be met by the fund's income distributions. Because a ROC represents a portion of your original investment, it is not taxable.
However, a ROC will reduce your ACB when calculating a capital gain or loss when you sell units of the fund. Any ROCs distributed to you while you held the investment must be tracked over time. A ROC will be reported on a T3 or T5 slip, but this amount may represent ROCs from several of the funds you own. Thus, you will have to confirm how much of this amount applies to a specific transaction.
