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investor clinic

Q: I own units of a real estate investment trust that distributes a significant amount of return of capital every year. I know that ROC must be subtracted from one’s adjusted cost base, but I was not aware until I read your column that once the ACB hits zero any further ROC payments are taxed as capital gains. As a result I have a negative ACB of about $13,000 on one of my REITs and I’m wondering what I need to do to make sure I don’t get in hot water with the Canada Revenue Agency.

A: You would need to correct your prior years’ tax returns, starting with the year that the ACB fell to zero. Any additional ROC received that year, and in subsequent years, would be reported on the corresponding return as a capital gain.

The process is not as onerous as you might think.

“You don’t refile the entire return, rather you change the return online,” said Jamie Golombek, managing director, tax and estate planning, with Canadian Imperial Bank of Commerce. “It’s just the one line. You forgot the capital gain so put in the amount of the taxable gain, which would be 50 per cent of the capital gain.”

(For more information, check out “How to change your return” on the CRA website)

You will be required to pay any taxes owing, plus interest, once your returns are reassessed. But “I doubt there would be any penalties. This isn’t a negligence scenario. You didn’t understand the rules, you didn’t understand the law,” Mr. Golombek said.

When you eventually sell the investment, make sure you use an ACB of zero (assuming you didn’t buy any more units, including reinvested distributions) and not the negative ACB to determine your final capital gain. Otherwise, you’ll end up paying double tax on the same gain.

Q: I am 27 years old and an aggressive saver. Having worked since the age of 22, I now have no debts and savings of $200,000 - with 35 per cent in stocks and ETFs and the remaining as cash. I am hesitant to invest the cash in today’s environment. What do you recommend?

A: If you are intending to buy a house in the next few years, then leaving a large portion of your savings in a high-interest savings account is prudent. You don’t want your stocks tumbling just when you need the money for a down payment. On the other hand, if you don’t expect to make a large purchase any time soon, then, for your age, a 35-per-cent weighting in equities is probably too low. According to an old investing rule of thumb, your equity exposure should be about 100 minus your age - or 73 per cent in your case. Given that lifespans are increasing and fixed-income yields are low, however, even that rule is now considered too conservative. Investing in banks, utilities, power producers, telecoms and other dividend-paying stocks - or purchasing a dividend-focused exchange-traded fund - will over the long run almost certainly beat the returns of a portfolio that’s heavy in cash. The downside is that you’ll have to live with greater volatility, but history strongly suggests that the trade-off will be worth it.

Q: We set up a registered education savings plan for our grandchildren in 2009 and bought some mutual funds from our bank. Unfortunately, the family moved to the United States and we are unable to make any more contributions. We turned the funds into cash with the idea to move the money to a self-directed RESP to avoid the high mutual fund expenses but it appears that this would entail opening a new RESP, which can’t be done as our grandchildren are no longer residents of Canada. So can we withdraw all the funds and what would the penalties be?

A: I asked Mike Holman, author of The RESP Book, to weight in.

If the RESP is terminated, “the owner of the account (grandparents) will get all of their original contribution amount back with no penalties,” he said. “However, any grant money in the account will be returned to the government.”

Regarding any income or capital gains that have accumulated in the plan, it’s a bit more complicated. In order for the grandparents to access this money all beneficiaries must have reached 21 years of age and the payment must be made “after the year that includes the ninth anniversary of the RESP,” according to the Canada Revenue Agency website.

If these and other conditions have been satisfied, accumulated income can be withdrawn by one of the subscribers and taxed at his or her marginal rate, plus an additional tax of 20 per cent, Mr. Holman said. The reader did not indicate the ages of the grandchildren, but because the RESP was opened in 2009, the second condition has not been met.

The grandparents could wait until all of the conditions are fulfilled before collapsing the RESP, although - depending on the age of the kids - that could be many years from now. Another option, Mr. Holman said, is to keep the RESP open so that, if the family returns to Canada and the grandchildren attend post-secondary school, they could use the RESP funds - including the grants and income - as intended.

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