I have held RioCan Real Estate Investment Trust units for nearly 20 years, and with the 2015 return of capital payment, the adjusted cost base has reached zero. I realize that part of the payment should be recorded as a capital gain, but I could find absolutely no place for this on Schedule 3 of my tax return. Where should I include this amount?
First, a quick refresher on return of capital (ROC).
When you receive ROC, whether it's from a REIT, mutual fund or exchange-traded fund, you don't pay tax on the amount immediately. Rather, you deduct ROC from the adjusted cost base (ACB) of your units. This will increase your capital gain (or reduce your capital loss) when you eventually sell your units. You'll find ROC in box 42 of your T3 slip described as "amount resulting in cost base adjustment."
As you indicated, if your ACB reaches zero before you sell your units, any further ROC distributions are taxed as capital gains in the year they are received. According to Dorothy Kelt of TaxTips.ca, because no sale of units actually took place, you would enter zero for "proceeds of disposition" on line 131 of your Schedule 3. In the "adjusted cost base" column, you would enter the negative ACB of your units.
For example, if your ACB was previously $1 and you received $3 of ROC in 2015, you would enter negative $2 for your ACB. Your "capital gain" on line 132 would therefore be your proceeds of zero minus your ACB of negative $2, which equals positive $2 (because subtracting a negative number is the same as adding the positive value of that number). The procedure is similar if you're using tax software – enter zero for your proceeds of disposition and the negative ACB for your adjusted cost base.
Your ACB then resets to zero for the following tax year and all further ROC distributions are taxed as capital gains.
Deducting ROC and adding reinvested distributions to one's ACB is a pain in the butt. Are there any websites to help with tracking one's ACB?
When do you sell a dividend position? Do you wait for the stock to hit a particular price-to-earnings (P/E) multiple?
My rule-of-thumb is simple: If a company's business is performing well and I expect the dividend to continue growing, I hang on to the stock for the increasing income. As Warren Buffett once said: "Our favourite holding period is forever." I only consider selling if a) the business has experienced a significant and potentially permanent deterioration or b) the stock has appreciated to the point where it accounts for an unduly large percentage of my portfolio. Generally, to control my risk, I like to keep a stock's weighting to about 5 per cent or less of my total holdings, but there is some wiggle room.
When is the best time to buy a dividend stock?
Often, general market slumps can be a good time to initiate or add to a position. Setbacks in a specific stock following an earnings miss or other short-term negative news can also present an opportunity.
Again, it's important to focus on the business; if the long-term outlook remains favourable, then a sell-off can be a good time to buy. However, there have also been situations where I had a price target in mind but the stock kept rising and never fell into my "strike zone."
What do you think of mutual funds?
For people who lack investing experience or just want to keep things simple, mutual funds can be a good choice. They provide diversification and let you reinvest distributions and make additional contributions with no commissions.
The main drawback is that some mutual funds have high ongoing costs that can erode your returns, so it's important to shop for a fund with a low management expense ratio (MER) relative to others in the category. Companies such as Mawer and Steadyhand offer several actively managed funds with MERs of less than 1.5 per cent and some of the big banks sell index funds that charge less than 1 per cent. I own a couple of low-cost funds, which I use as a vehicle to reinvest dividends in some of my accounts. Google "low-cost mutual funds" and set aside several hours for reading.