When you invest in stocks, any profits you gain on them are usually taxable. While many of us don’t really pay attention to this, capital gains on equity investments are heavily taxed by the Canada Revenue Agency (CRA). As exciting as it is to gain huge profits through investing, managing your taxes efficiently has significant benefits.
When there is a price appreciation in a stock that you own, it is known as a capital gain and when you sell it in at a profit, you are subjected to a capital gains tax and the CRA applies a tax of 50% on your capital gains.
For example, if you buy a stock for $10,000 and you sell it for $30,000, then you will have $20,000 capital gain and you have to pay taxes on this amount which might be as much as $10,000.
However, there are several easy ways to reduce capital gain taxes.
Holding stocks for more than one year
As an investor, you should always try to hold an investment for longer than a year. When you hold a stock for less than a year, you are taxed at a rate similar to your general tax bracket.
But, when you hold investments for more than a year, there can be a difference in your income or any other factor that can affect your overall taxable income which means you are generally taxed lower than holding it for a shorter time.
Further, equities should be viewed as long-term investments to benefit from compounded returns. Selling stocks for a profit within one year are subject to short term capital gains tax (STCG).
Similarly, selling investments after a year with a profit are subjected to long term capital gains tax (LTCG).
When to sell your investments?
Timing the sale of your investments can be a great way to help investors save on taxes. If a certain stock has increased in value and you are planning to sell it shortly, see if you can postpone the sale until January 1st of next year.
This is because you will have to pay capital gains tax in the year you sell your investment i.e. you will pay tax on the 30th of April in the following year.
Along with this, if your income varies then you can wait and sell the investments in the year you have a lower income as the capital gains tax rate is determined by your marginal tax rate, and the lower your income, the lower will be your tax-rate.
Holding investments in your TFSA or RRSPs
Using tax-advantaged accounts like the RRSP (Registered Retirement Savings Plan) and TFSA (Tax-Free Savings Account) can also help you save considerably on taxes.
According to Million Dollar Journey, the strategy behind RRSPs is to contribute to the account, let it grow tax-free, and withdraw investments when you belong to a lower tax bracket in retirement.
Your RRSP contributions and investment growth are taxed upon withdrawal and since RRSPs are essentially retirement accounts, by the time you withdraw your investments you will be taxed at a marginal rate. So, you are able to invest money when you belong to a higher tax bracket and withdraw when you belong to a lower tax bracket.
TFSAs withdrawals in the form of capital gains, interests, or dividends are exempt from Canada Revenue Agency taxes. Here you don’t have to pay taxes on profits you make through your investments and you don’t have to pay taxes even on withdrawal. This is because you have already paid taxes on the amount you contribute to your TFSA.
While the contribution limit for a TFSA is limited each year, you can make maximum use of it by maxing out your annual or cumulative contributions. Further, you can try to invest in stocks that have high growth potential so you can withdraw a good amount without having to pay taxes.
Understanding tax-loss harvesting
Tax-loss harvesting, also known as tax-loss selling simply means that investors can sell stocks at a rate lower than the amount you bought it in or at a loss. This is a strategy that works when you have at least one stock that is trading significantly lower than its purchase price.
You should also note that you can claim this only through non-registered accounts and not your RRSP or TFSA.
According to Wealthsimple, the Canada Revenue Agency does not look favorably on investors who sell low performers at a loss and then buy them back a few days later. This “superficial loss” applies to assets that CRA would consider “identical.”
For example, if an investor sells shares of ABC Company at a loss and buys them back weeks later and the CRA deems your transaction a superficial loss, you will not be able to use it to offset the capital gains and you can also put yourself under scrutiny or an audit in the future.
Donating to charity
If you donate some amount to charity it may give you a return benefit. Instead of selling stocks at a profit and paying a tax on gains, you can donate this stock to a registered charity.
You will then receive a receipt for tax purposes and not trigger capital gains tax. This re-balances your portfolio because you are not selling the stock, but are just transferring its ownership.
Capital gain taxes may not seem a lot for a small profit but it may put a huge dent in your pocket when your gains increase multifold in an unregistered account. Investors should travel the extra mile by managing taxes smartly and gaining maximum returns.