• It may not always be clear whether you should treat your investment profits and losses as capital or income.
• Where possible, you'll want to argue that your profits are capital gains and your losses are business losses. It may be possible to treat different investment accounts differently in this regard. Visit a tax pro to talk this over.
• Document your reasoning and be consistent from one transaction to the next, and one year to the next.
Tim's Tip 52: Claim a capital gains reserve to spread your tax bill over time.
Ah, yes, one of the mysteries of the universe-how to avoid tax on capital gains when an asset has appreciated in value. It's not an easy question to answer. I wish more magic were available here. Your best bet in this situation may be to push the expected tax bill as far off into the future as possible. You can do this simply by not selling the asset. But if you're determined to sell, you can at least minimize the tax hit by spreading it out over a maximum five-year period.
You see, the tax collector will allow you to claim what is called a capital gains reserve-a deduction-when you have sold something at a profit but have not yet collected the full amount of your proceeds from the sale.
Lisa decided last year to sell the family cottage. She had bought it for $75,000 and was offered $175,000 for it-a $100,000 profit she couldn't refuse. She wasn't able to shelter this $100,000 capital gain in any way, so she decided to take payment from the purchaser over a five-year period-$35,000 each year. This way, the capital gain was not taxed all at once last year. Rather, Lisa will pay tax on the gain over the five-year period-she'll report just $20,000 each year. She reported the full $100,000 capital gain last year, but claimed a capital gains reserve for 80 per cent (four-fifths) of the gain. The gain will be taken into income slowly over five years.
You'll have to take any capital gains into income at a rate not less than 20 per cent (one-fifth) each year. If you're not keen on the idea of taking payment over five years because you're giving up use of the proceeds today, there's a simple solution: Build an "interest" charge into the selling price so that you're compensated for the time delay in collecting payment. For example, Lisa could have collected, say, $37,500 each year rather than $35,000-for a total selling price of $187,500. The additional $2,500 each year is like interest income, but the good news is that it should be taxed as a capital gain (only one-half of capital gains are taxable) if you build it into the selling price!
TO MAKE A LONG STORY SHORT:
• It's very difficult to avoid paying tax on accrued capital gains on assets you own.
• Your best bet may be to push the tax bill as far into the future as possible.
• A taxable capital gain can be spread out for up to five years by taking payment of the proceeds over an extended period. This is called a capital gains reserve.
Tim's Tip 53: Consider investing to earn eligible dividends for big tax savings.
Some big changes were introduced in 2006 that will impact Canadian investors for years to come. By way of background, the federal government had been concerned about the amount of money being invested by Canadians in income trusts. Why?
Because income trusts can result in a significant deferral of tax for investors (see Tip 56 for more). To stem the flow of money invested in income trusts, the federal government proposed to equal the playing field between income trusts and publicly traded shares so that investors may be less inclined to invest in income trusts and more inclined to invest in shares.
What did the feds do? They reduced the tax rate on eligible dividends from certain Canadian companies. Let's take a look at the new rules.
Lower Tax Rates
Eligible dividends from Canadian companies will be subject to lower tax rates than ineligible dividends. You see, eligible dividends will benefit from a 45 per cent gross-up (as opposed to a 25 per cent gross-up for ineligible dividends) and a larger dividend tax credit equal to 18.97 per cent of the grossed-up dividend (13.33 per cent for ineligible dividends). The end result is a lower marginal tax rate on eligible dividends (see the marginal tax rate tables starting on page 297). In fact, it's interesting to note that, at certain income levels, eligible dividends may have a negative marginal tax rate (more about this in a minute).