For conservative investors, the urge to keep money in cash or the equivalent is hard to overcome, despite today’s low interest rates.
And yet, seeking safety in income-producing investments and cash may sometimes buy you a tax problem. In those situations, you may need to change your investment plan.
If you are holding stock that has an accrued gain – but are convinced that it’s still safer to trigger a capital gain on the sale of that stock and hold the resulting funds in cash – here are some ways that you may be able to shelter or offset the capital gains tax:
Bad Loans. Included here are things like bad mortgage investments or junk bonds (or even a no-good advance to your company or bad loan to a business associate).
To obtain a deduction, the loan must generally be interest bearing. So if you made a loan to a relative on an interest-free basis, for example, the CRA can take the position that the loan was not taken out for income-earning purposes. Therefore, no loss is available to begin with.
An exception arises if you are a shareholder of a Canadian corporation and have advanced the money to it on a low- or no-interest basis. In this case, and if certain conditions are met, the CRA will give you at least a capital loss on the bad loan.
When is a loan bad? The government’s position is that claiming a bad debt loss on a loan is basically an all-or-nothing proposition: the whole of the loan must be uncollectible, or when a portion of the debt has been “settled”, the remainder must be uncollectible.
Also, you must have exhausted all legal means of collecting the debt, or the debtor must have become insolvent with no means of paying the debt.
Out-of-business companies. Another overlooked source of a tax loss is an investment in a company that has gone bankrupt or is now worthless because of insolvency and cessation of business activities. This may often include a company that has been delisted from a stock exchange.
Note: If a bad investment is in a Canadian private company which was devoted to active business, the loss could qualify as an “Allowable Business Investment Loss” (ABIL). If so, this type of loss can be deducted against any type of income, whereas a normal capital loss can only be deducted against capital gains.
Beware, however, that if you claim an ABIL, it has become standard procedure for the CRA to follow up with more questions to ensure that the ABIL is being properly claimed.
Bonds purchased at a premium. If you have invested in a bond (outside your RRSP), it is possible that you purchased it at a premium over its redemption price because the coupon rate on the bond itself was higher than comparable interest rates when you bought the bond.
In these cases, there will probably be a capital loss at maturity or if you have sold it.
“Last chance” capital gains election. Check your 1994 return to see if you have made the “last chance” election to take advantage of the now defunct $100,000 capital gains exemption. For most investments, this will result in an increase to the cost base of the particular item, which in turn will reduce your capital gain.
That also assumes, however, you have held the particular investment since before 1994. (If your gain is on a mutual fund and you made the election on it, you may have a special tax account – known as an “exempt capital gains balance” – which can be used to shelter capital gains from the fund.)
Check your carry-forward balances. Another thing you can do is check to see whether you incurred capital losses in a previous year which you never used.
This is quite possible, because deductions for capital losses can only be claimed against capital gains, and unclaimed capital losses can be carried forward indefinitely. If you don’t have back records, another idea is to contact the CRA to request your personal carry-forward balances.
Have your kids report Capital Gains. If an investment is owned by your kids, the gain can be reported on their tax return. This could dramatically slash (or even eliminate) the tax bite.
Here’s why: Every Canadian individual, irrespective of age, is legally entitled to the basic personal exemption, which covers off the first $11,138 of income (for 2014).
And with the 50 per cent capital gains inclusion rate, this means that kids with no other income can now earn just over $22,000 of capital gains annually, without paying a cent of tax.
And what if the gain exceeds this amount? Since your kid pays tax on the gain in the lowest tax bracket, the tax rate is still only about half of what a high-income earner would pay. (Note: the parent who funds the kid’s investment must normally pay tax on interest and dividends generated by the investment until the year the child turns 18.)
Sometimes, people hold an investment for their kids (e.g., as a gift) but it is registered in the name of the adult. This isn’t necessarily a show-stopper.
For one thing, if the account is registered in your name “in trust,” this may show that it is really for your kids. Another option is to visit a tax advisor to discuss the possibility of documenting the fact that the investment is for your kids, e.g., by filling out a legal declaration of trust.
Defer with Reserves. If you sold an investment for a capital gain, but you are not entitled to receive the cash proceeds until the end of the year, you are allowed to defer a portion of your capital gain until next year by claiming a “reserve”. Basically, reserves may enable you to defer your tax on capital gains over a five-year period.
Tax-Loss Selling. And, this should almost go without saying, but if you are looking to get out of stocks, there’s a chance that for every stock that has an accrued gain, you may have another one that is sitting in a loss position. So, simply engage in tax-loss selling, and sell off some of your losers to offset your gains.
The TaxLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846
The TaxLetter •7/3/14 •