Capital gains and losses offer a number of tax advantages for reducing amounts owed on your federal return. Average investors planning for retirement look to retirement savings plans, pensions and tax-free savings accounts, but there may be situations where claiming capital gains or losses might save you money on investments outside of typical retirement savings vehicles.
Understanding Capital Gains and Losses
“Capital gains and losses refer, in essence, to the difference between purchase and sale prices for capital properties, as defined by the Canada Revenue Agency,” says Terry Baker, fellow chartered insurance professional with Investors Group in London, Ontario. “When the sale price is higher, you’ve earned a capital gain. When it is lower, you have a capital loss.” The CRA defines capital property as depreciable property that, if sold, would gain or lose money, typically purchased for investment or income purposes. Common types of capital property include second homes, land or equipment used for rental income, and stocks, bonds or shares.
Reporting Capital Gains
There are two courses of action you may use in the case of a capital gain. Depending on your situation, you may claim a capital gains deduction, or declare a capital gains reserve. The capital gains deduction is claimed by completing schedule 3 for the current tax year, to report eligible capital gains from all sources. Once totaled, 50 percent of this amount is calculated and transferred to line 127 of your tax return as your taxable capital gain amount. Claiming a reserve happens when you receive payment for sale of your property over time. In addition to schedule 3, complete form T2017, Summary of Reserves on Dispositions of Capital Property. For example, if you sold property worth $50,000 with an agreement to receive annual payments of $10,000, use form T2017 to calculate your annual capital gain amount. You must sell the capital property to claim the capital gain. As the property sits in your portfolio, it is not subject to gains or losses, though it may be active in your tax situation as a depreciation or capital cost allowance.
Reporting Capital Losses
Just as with capital gains, capital losses are reported using schedule 3, and allowable losses may be used to offset gains within the current year, up to three years prior, or carried forward to future years, depending on the situation. For example, capital gains on personal property items are earned and reported, but capital losses on these items may not be eligible. Losses are somewhat more restricted than gains, and carrying losses forward requires calculation of a capital loss adjustment factor, which depends on the carrying year. Despite the additional calculations, since capital losses apply directly to offset taxable capital gains, the tax savings may be worth consideration.
Minimizing Tax Using Capital Gains and Losses
Since capital gains and losses come into play only when you dispose of qualifying personal property, planning when to sell an item may be strategic. For example, if you plan to sell a stock for a profit near the end of a calendar year, delaying until January defers paying tax on the capital gain until the tax return is due in April, 15 months in the future. Since capital losses offset capital gains, if you have an unavoidable loss, you may choose to sell a capital property that results in a gain. The loss legally shelters your gain, so you could re-invest both your original investment and the amount it has earned, increasing your cost base on the new investment, reducing the amount of future gains, and therefore also the tax liability.
References & Resources
- Canada Revenue Agency: Calculating and Reporting Your Capital Gains and Losses
- Terry R. Baker, B.A. FCIP; Investors Group, London, ON