More than 340,600 Canadians had unapplied capital for the 2007 tax year, according to Canada Revenue Agency. After 2008, it is expected to rise significantly.
This number does not reflect the many individuals who may have losses within an RRSP account. When you receive your income tax Notice of Assessment, people with losses should see a statement that indicates the dollar amount of the net capital losses from other years.
If you have net capital losses then we have some tips for you:
Structure – Generally high-risk investments should be in a non-registered account. Low risk investments, including fixed income should be in your registered accounts. The downside to having higher risk equities in registered accounts such as RRSPs or Tax Free Savings Accounts, is that losses within these accounts are not applicable for tax purposes.
Let’s use Don who invested on his own and had accumulated $100,000 in savings within his RRSP. At the beginning of 2008 Don was feeling bullish on material and energy stocks and decided to invest 100 per cent in equities. At the end of 2008, Don had lost half of his RRSP savings. If Don pulled the $50,000 out of his RRSP he is still taxed on that amount. In addition, he will not have any carry forward room. This is distinctly different than having the funds in a non-registered account where Don would have $50,000 in capital losses if the investments were sold. One half of this amount, or $25,000, is considered a net capital loss and may be applied against taxable capital gains.
Taxation – Net capital losses within non-registered accounts may be carried back up to three years, and forward indefinitely, to apply against taxable capital gains. Higher risk investments should generally be held within a non-registered account to take full advantage of the rules on losses and the tax advantages of deferment on gains.
Fee Based Account – One of the many features we like about fee-based accounts is the ability to deduct fees annually. Investment council fees for non-registered accounts may be deductible on Schedule 4 of your income tax return. By stripping these fees out, you are essentially doubling the amount you can deduct on your tax return, regardless of whether the markets are rising or declining. In addition, you are speeding up the deduction, as you do not have to sell the underlying investment to claim these expenses. If transaction costs are removed from all purchases and sells, then it is more likely that the underlying investment will generate a capital gain.
Timing – Timing can make a huge difference for investors entering the market. Investing too much at one time may result in you taking on too much market risk. Bad market timing for equities can result in some investors wanting to liquidate investments at the wrong time and converting to interest bearing investments. Unfortunately interest income may not be applied against net capital losses.
Growth Investments – Financial firms often have listings of the highest dividend paying stocks. This is primarily to fulfil income needs for people searching for high yielding investments. We like dividend paying stocks; however, the greater the dividend, the less the company is retaining for growth. Please note that by growth stocks we are not suggesting small companies with little to no analyst coverage. It is possible to purchase larger companies focused more on providing capital growth than dividends. Ask your financial advisor for a listing of their top growth stocks.
Bonds – Bonds should generally be held within your registered account. If your risk tolerance is low, and you have net capital losses from other years, you should look at the secondary bond market. More specifically you should look for bonds trading at a discount (below 100) for your non-registered account. Bonds purchased at a discount, and held to maturity, generate a combination of interest income and capital gains. Your investment advisor should be able to provide you a list of bonds trading at a discount.
Flow-Through – If you are in the top marginal tax bracket, and you have a high-risk tolerance, then it is worth having a discussion regarding flow-through shares. These types of investments generally allow a full deduction for the initial investment. Most flow through investments report annual tax information on a T5013; however, no slip is provided to record the final disposition. When a flow-through investment is sold (generally a minimum of 18 months or 2 years), a portion or all of the proceeds are considered a capital gain. Most companies issuing flow through shares have a website with tax information to assist investors and accountants in this calculation.
Real Estate – Capital gains may also result in other property, such as rental properties, vacation homes, and other real estate holdings. Capital losses from investment holdings may be applied against real estate sells.
Spousal Transfer – If your spouse has capital gains then you could arrange to trigger the superficial loss rules by having your spouse purchase the identical property that you sold within 30 days. By doing this, you may be able to abuse the attribution rules and transfer the loss to your spouse. In order for your spouse to use the loss, they must not sell the identical property within the 30-day period.
Professional Advice – Ensure you have a qualified financial professional to assist you. If you are not happy with the performance, or service, you are currently receiving then we encourage you to explore your options. In other words, you should look for a second opinion. You should speak with your accountant before implementing any tax related strategies.