Minimizing Capital Gains Tax

Allan Madan, CA
 Dec 4, 2013
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A lot of people pay way more tax more than they need to on net capital gains. Most people do not realize there are a few ways to reduce and sometimes eliminate capital gains altogether. In this article I will talk about a few different, but simple ways you can reduce your capital gains tax for the year.

How RRSP contributions can minimize capital gains tax?

One of the easiest and widely used ways to reduce capital gains tax is by contributing the funds from the sale of a properties like land, buildings, shares of public companies or even a second home to a RRSP.

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Contributing to your RRSP using the funds received from the sale of property can be used to reduce your taxable income. It is a good idea to invest in a RRSP especially if you have contributions accumulating from previous years. Click here to find out the yearly RRSP contribution limit.

One important aspect of RRSP contributions often missed is that unused contributions can be carried forward indefinitely and can be used to reduce taxes later. If there is an expected income increase in the near future, which will increase your tax bracket, then the RRSP contributions are better off left unused. The unused RRSP contributions can be claimed in the future for bigger tax savings.

However, no tax saving is provided on the funds that are contributed over and above the yearly contribution limit available. Click here to find out your unused RRSP contributions.

How to reduce your net capital gains?

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Increasing capital losses is a method to save tax on capital gains. The term ‘net capital gains’ is defined as: profits from the sale of property less losses from the sale of property. Therefore, increasing your capital loss will reduce your net capital gains, which are taxable to you. Realizing the loss in the current taxation year can sometimes be more beneficial for tax purposes than holding the property and selling it later for a smaller loss.

For example: An investor named Bob bought 1000 shares of Apple Inc. at a price of $500/share a year ago. The price of Apple Inc. shares have gone up to $600/share. He also bought 1000 shares of Amazon.com Inc. at a price of $300/share, now the price of those shares is trading at $275/share.

He is at a profit of $10,000 [(300-200) x 10,000] = $10,000 from his Apple Inc. shares. He is at a loss of $2500 [(275-300) x 1000] = -$2500 from his Amazon.com Inc. shares.

Bob decides to sell his Apple Inc. shares to cash his profit of $10,000 from those shares but he decides to hold his Amazon.com Inc. shares until the stock’s price recovers. Bob will be paying capital gains tax on the full $10,000 gain, even though he only made $7500.

Bob can sell the Amazon.com Inc. shares and use the loss to pay less tax on his gain. If he decides to sell his Amazon.com Inc. shares, he will only be paying tax on $7500 net capital gain.

Many investors who trade equities sell their losing stocks to create a capital loss for tax purposes. However, if you repurchase the security within 30 days of the sale the capital loss is denied as your purpose for selling the security was superficial and for tax purposes only. Tip: Do not repurchase money losing stocks that you sold within 30 days of the sale.

A similar technique can also be used if you and your spouse both own stock of public companies. For example, if you have some winning stocks and your spouse has some losing stocks, then you can take advantage of rolling over property between spouses or common-law partners tax free. After the property is rolled over in your name, you can sell the winning stocks and the losing stocks to pay less tax on the net capital gains.

How to effectively use capital gain reserves?

The capital gain reserve is available for taxpayers that sell their property but do not receive the proceeds from the sale right away. For example, Bob decides to sell a building he bought 3 years ago for $500,000. The building is now worth $800,000. The taxable capital gain is $300,000, however, Bob agreed to let the buyer pay him in 8 equal payments of $100,000 every year.

The CRA gives a capital gain tax break to sellers who do not receive all of the proceeds in the year of sale. What that means for Bob is that he will not have to pay tax on the full $300,000 capital gain. Instead, he will be able to defer his capital gain for up to 5 years using a method called capital gains reserve. The reserve contains the amount of capital gain still to be taxed and it goes down every year as the capital gain tax is paid. It is calculated for Bob in the year of sale as follows:

Formula Bob’s Calculation
  Lesser of:   Lesser of:
Proceeds still to be received in future/Total proceeds x gain $700,000/$800,000 x $300,000 = $262,500
(4 – n)/5 x gain (n is # of years since disposal) (4-0)/5 x $300,000= $240,000

The capital gain reserve balance for year of sale is $240,000 and the capital gain taxable is $60,000. Click here to find out more info on capital gain reserve.

How can you use donations to pay less tax?

Another way to reduce your capital gains tax is by donating properties like land, building, shares of public companies and even art to registered charities. If you were thinking of donating cash to a charity by selling a property, then it might be better idea to donate the property itself.

For example, Sharon bought a piece of land for $2000 5 years ago, now that land is worth $10,000. Sharon is planning on donating $10,000 to the Sick Kids foundation by selling the land and donating the cash. When Sharon sells the land she will have to pay tax on the $8,000 capital gain. She will have to add more cash from her pocket to be able to donate $10,000.

Alternatively, Sharon can donate the land itself to the Sick Kids foundation and they can sell the land themselves. Registered charities do not pay tax on any capital gains. This donation will not cost Sharon anything more than what she paid 5 years ago. The value of the donated property can be used as a deduction from your taxable income (up to 75% of your taxable income). Thus, Sharon can deduct $10,000 from her income.

These simple tips can be used by most people to lower their tax payable to the CRA. The tax savings can sometimes be significant by just implementing a few or all of the methods mentioned above.

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.

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