Archive | Taxes

How to Avoid Paying Other People’s Taxes

Before you go shopping for the Couch Potatoes on your holiday wish list, be aware that December can be a terrible time to buy ETFs.

No, it’s not because of all the last-minute shoppers pushing and shoving at the discount brokerage. The reason is that any capital gains that the funds have incurred over the last 12 months are distributed at the end of the year. Although they’re called “distributions,” capital gains are not handed out in cash like dividends or interest. You don’t receive any new shares, and the market price of the ETF won’t change. All you get is a T3 slip showing the amount of the gain, which you’ll need to report on your tax return.

Their gain, your pain

In general, ETFs are extremely tax-efficient, especially if they track broad, cap-weighted indexes. Funds incur capital gains when they sell securities at a profit, and passively managed funds don’t do a lot of selling. (The ETF structure may allow fund managers to avoid taxable gains even when they do sell stocks.) However, a fund may have no choice but to realize capital gains when its benchmark index is changed,

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Tax-Loss Selling with Index Funds: Part 2

In my previous post, I looked at the Canada Revenue Agency’s position on tax-loss selling with ETFs. According to the only CRA bulletin on the subject, if you sell an index fund or ETF and claim a capital loss, you must wait 30 days before repurchasing another fund that tracks the same index, even if the funds are from two different financial institutions. Otherwise, the sale will be considered a superficial loss, and you won’t be able to use it to reduce your taxable capital gains.

There are many reasons why this might be called unfair: two funds that track the same benchmark may have different fees and slightly different holdings, and they certainly can’t be expected to perform exactly the same. But whether we like it or not, the CRA considers them identical property, and investors who ignore that interpretation risk having their capital loss claim denied.

If you’re a Couch Potato who’s looking to harvest some losses in a non-registered account, your goal is to stay within the CRA’s rules while also keeping your market exposure as consistent as possible.

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Tax-Loss Selling with Index Funds: Part 1

Now that we’re into December, many investors are turning their thoughts to skiing, holiday celebrations — and year-end taxes. If you’re investing in an RRSP, Tax-Free Savings Account, Registered Education Savings Plan (RESP), or other tax-sheltered account, you can ignore what follows. But if you’re a Couch Potato with a taxable account, you may be able to reduce the Canada Revenue Agency’s share of your investment returns with a strategy called tax-loss selling.

First, a primer on how capital gains are taxed. Any time you sell a security (a stock, bond or fund) at a profit in a taxable account, you trigger a capital gain. When you file your return, you need to report half of your capital gains as income, and you’ll pay tax on that amount. For example, suppose you put $10,000 into an ETF that is now valued at $17,000. Selling it would incur a $7,000 capital gain, and you’d have to report $3,500 in income on your return. If your marginal rate is 30%, that will cost you $1,225 in taxes.

The good news is that you can use capital losses to offset your gains. Let’s say in addition to your $7,000 capital gain you also sold a different ETF that had declined by $5,000.

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Holding US Dollars in Registered Accounts

RBC Direct Investing recently became the first bank-owned brokerage to allow Canadians to hold US dollars in registered accounts, such as RRSPs and Tax-Free Savings accounts (TFSAs).

This is a welcome move, and we hope the other banks will follow suit. (Questrade and Qtrade have allowed US dollars in RRSPs for some time.) The cost of converting loonies to greenbacks in an investment account is significant — indeed, it’s the main reason why Canadians are often reluctant to use low-fee ETFs from US providers.

But holding US dollars in a registered account also raises a number of practical questions. A reader, Graham R., emailed to ask how US-dollar transfers to RRSPs are treated with respect to contribution limits. For example, let’s say he moves $10,000 US into his retirement account today. Early in 2011, before tax time, the brokerage will send Graham a tax slip indicating the amount of his RRSP contributions. Will this amount be indicated in US or Canadian dollars?

I spoke to Michael MacDonald, head of business strategy at RBC Direct Investing, who clarified how this works.

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