How to gain from capital gains and losses

By:  Kian Ghanei, Vancouver

It's always a good thing when an investment pays off. That's why you invest, after all - to win - not to lose. But when you win on an investment, there is almost always a price to pay in the form of taxes.

The past year or so has seen a resurgence in the market that has brought about a corresponding upswing in returns for many stocks and mutual funds. But don't forget about the not-so-good times when you may have experienced capital losses, because you'll likely be able to use them to reduce your current tax bite.

Here are a few basic tax tips aimed at helping you keep more of what you earn and turning capital losses into tax wins.

Taxable income: You are taxed on your income according to progressive tax rates that increase as your income grows. Marginal tax rates, tax brackets and surtaxes vary by province, but the tax bite on your income ranges from 20 to almost 50%, depending on your province of residence and your taxable income.

Investment income: Your investment income can increase the amount of income tax you pay by increasing your total income and moving you into a higher tax bracket. But investment income is taxed in different ways, and knowing these differences can help you save on taxes:

• Interest income - from bonds, Guaranteed Investment Certificates (GICs), term deposits and other fixed-income investments - is fully taxable at your marginal rate of tax.
• Dividend income on stock holdings from Canadian corporations that qualify for a Dividend Tax Credit is generally taxed more favourably than interest income.
• Capital gains - on stocks, real estate, or securities like bonds or mutual funds that you purchased as an investment - are usually triggered when you sell a capital property for more than you paid for it. You can also have a capital gains distribution from a mutual fund or trust. Only 50% of a capital gain is included in your income for tax purposes^[1] so it's simple math that capital gains deliver the biggest tax break, in higher tax brackets.
• Capital losses occur when you sell a capital property for less than you paid for it. But, capital losses can only be used to offset taxable capital gains. Although these losses cannot be used against other income, if they are not used in the year they occur they can be carried back and applied against taxable capital gains in any of three previous years; they can also be carried forward indefinitely.

Mutual fund gains or losses: When your mutual fund sells some of its securities that have appreciated in value, you may receive the flow-through of those capital gains in the form of a distribution. You can also earn capital gains on your mutual funds when you sell your units after they have appreciated in value. If you receive capital gains either from a distribution from the fund or by selling your units, you are taxed on 50% of the gain. If your mutual fund had capital losses in any of the last three years you can use those losses to offset current gains.

With the right investment strategies, you can trim the taxes on your non-registered investments while reducing your taxable income and deferring taxes through the effective use of registered plans. Professional financial advice can help you implement the strategies that work best for your overall investment program.