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Taxes A proper adjusted cost base can lead to tax savings

A couple of years ago, Margarita Tsvitnenko of Moscow and her husband were splitting up their assets upon divorcing. Their biggest asset was their very expensive home. They couldn’t agree on what to do with the home, so the court ordered the couple to build a brick wall down the middle of the place, dividing their two sides. The problem? Margarita’s husband had a right to the existing staircase, and the builder simply erected the new brick wall without Margarita having a staircase in place; she couldn’t get upstairs and a friend of hers, who was upstairs, became trapped.

Strange. There are a lot of questions that come to mind in this story. Leave it to a tax geek to ask this one: What is Ms. Tsvitnenko’s adjusted cost base of her home now? The question of the correct adjusted cost base (ACB) is important for every Canadian taxpayer. Why? Because many don’t calculate ACBs properly, which can cause you to lose out on tax savings.

The higher your ACB, the less tax you'll pay on the eventual sale of an asset. Before filing your 2018 tax return, make sure you've properly calculated your ACB on assets sold in 2018. Consider these common scenarios.

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Identical properties. The most common example of identical properties are shares of the same class of a corporation or units of a mutual fund. You need to use the average cost when arriving at your ACB for each share or unit.

Reinvested distributions. If you own mutual funds outside your registered plans, chances are good that you've received distributions that were reinvested. The value of these reinvested distributions should be added to the ACB of your funds so that you don't pay more tax than necessary.

Returns of capital. If you own investments and have received a return of capital, don't forget that the return of capital reduces your ACB in the investment. If you sold any of these investments in 2018, remember to calculate your ACB correctly. You should find the return of capital figure in box 42 of the T3 slip you receive from the investment.

Capital improvements. If you sold a piece of real estate in 2018, be sure to add the original cost of the property plus any capital improvements you made when calculating your ACB. If you don’t have receipts to substantiate the improvements, make your best guess at the amounts and add them anyway, if they are legitimate. If the taxman comes knocking later and asks for receipts, you may have a challenge adding those amounts in the end, but it’s worth a try.

Inherited assets. If you inherit assets from someone other than your spouse, your ACB will generally be equal to the fair market value of those assets on the day you received the assets. If you sold any of these assets in 2018, be sure you know your correct ACB to avoid paying more tax than you should. Assets received from a spouse generally transfer at ACB, so the recipient spouse typically inherits the same ACB as the transferor spouse.

Stock option shares. If you acquire shares under a stock option plan at work, your ACB of the shares will not be the amount you paid for the shares (your exercise price). Rather, your ACB will equal the amount you paid, plus any taxable benefit that should have been reported on a T4 slip to you in the year you exercised the options. In short, your ACB should equal the fair market value of the shares on the day you exercised your options. Speak to a tax pro for more help.

Changes in use. If you changed the use of a property from personal-use to income-producing, or the other way around (perhaps you had a rental property that you’ve decided to now use as your residence), you’re deemed to have sold the property at the time of the change, and to have reacquired it at that same time. This can trigger a taxable capital gain at the time of the change, but also creates a new ACB for the property equal to the fair market value at the time of the change.

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Stock splits. A stock split takes place if a company’s outstanding shares are divided into a larger number of shares without changing the total market value of all the shares combined. A two-for-one stock split, for example, will double the number of shares but cut the value of each share in half. A stock split is not taxable, but your ACB of each share must be recalculated. Simply take the total purchase price of all your shares and divide it by the new number of shares.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at tim@ourfamilyoffice.ca.

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