Wealth Management: Winning with Capital Gains

Investing in assets that have the potential to accrue in value can come with both risks and rewards. From a tax point of view, a capital gain on those assets has two distinct advantages: there is no taxation on accrued values until disposition (actual or deemed), and only one half of the gains are added to taxable income. Here’s why it’s important to fully understand the advantages:

Simply put, acquiring assets with the potential to earn a capital gain can be a lucrative means of accumulating wealth over time. When these assets produce diversified income sources in the future —dividends, rents, ND royalties, for example - aside from the potential for capital gains, all of these attract lower marginal tax rates than ordinary income including interest throughout your lifetime.

Remember that on disposition, only 50% of a capital gain is added to taxable income, at least under current rules. Capital losses, could result, but these can be used to offset current year gains. If there are none, capital losses can be carried back to offset gains in the prior three years or carried forward indefinitely to offset future capital gains.

Experienced tax help is important before you buy, sell or transfer capital assets, as there are special tax rules associated to various types of assets and transactions, some of which are illustrated below. But the bottom line is this: despite the complexity, adding capital assets to your wealth management plan is a smart tax move.

The following are some true-to-life examples excerpted from Essential Tax Facts, 2019 Edition on how to win with capital gains:

TRUE-TO-LIFE EXAMPLE 1 - Donate Shares to Charity for a Multiplicity of Benefits. Diana purchased shares for $5,000 several years ago. The shares have done well and are now worth $15,000. If she donates the shares to a registered charity with a direct transfer out of her investment account, she will receive a donation receipt for $15,000 and will not have to pay taxes on the $10,000 capital gain.

If she were to sell the shares and donate the proceeds, she would still receive a donation receipt for $15,000 but she would also have to report and pay tax on a $5,000 taxable capital gain. Best to do the transfer of the shares, for a gift that keeps on giving.

TRUE-TO-LIFE EXAMPLE 2 - Mutual Fund Transactions. Scott purchased 1,000 units in an equity fund last year. The cost of the units was $12.40 per unit. He received a T3 slip showing that income of $254 was allocated to him. Rather than receiving the $245 in cash, he received 20.32 additional units in the fund.

This year, he decided to move his investment into a bond fund with the same company. The 1,020.32 units of the equity fund were exchanged for 539.96 units in a bond fund with an ACB of $12,662.17.

The ACB of the bond fund units at the time of the transaction will be the deemed proceeds of disposition of the equity fund units.

The ACB of the equity fund units is $12,400 (original cost) + $254 (income allocated to Scott last year). Scott will report a capital gain of $12,662.17— ($12,400 + $254) = $8.17.

Tax Moves - Adding capital assets to your investments will help you to accrue value on a tax-deferred basis until there is an actual or deemed disposition of the property.

Additional Educational Resources: If you want to learn more about winning with Capital Gains and other tax-efficient means of investing, Knowledge Bureau offers Tax Strategies for Advisors as part of the MFA-Retirement and Succession Services Specialist™ designation or as a certificate course. Take a Free Trial Today!

For an overview on getting the most out of filing taxes, Essential Tax Facts, 2019 edition has all the latest in tax for the 2019 filing season—including true-to-life examples, audit checkpoints, tax moves, and checklists to help you and your clients navigate tax-efficient planning and filing.