Managing capital gains and losses

“Capital gains are only taxed when they are realized,” says Henry Korenblum, manager, tax, with Crowe Soberman LLP in Toronto. “That is, when a security is sold.” Therefore, he adds, if your clients have made gains on a security they hold, the taxes on the unrealized capital gains can be deferred by deferring the timing of the sale of the security.

“You should not let the ‘tax tail’ wag the dog,” Korenblum says, “because the merits of an investment decision and your future outlook for a security should be your primary consideration. And taxes, although important, should be secondary.”

But if your clients must sell, they will benefit from the favourable tax treatment of capital gains, as compared with other types of investment income; clients will pay taxes on only 50% of the capital gains they make when they sell a security. Looking at it another way: at the highest marginal tax rate in Ontario, the federal and provincial tax rate on capital gains for 2014 is 24.76% – significantly lower than the tax rates on eligible dividends (33.82%) and other income (49.53%).

The decision to realize capital gains should be taken in context with a client’s investment plan, advises Dennis Tew, chief financial officer with Franklin Templeton Investments Corp. in Toronto. For example, he says, if some clients wish to rebalance their portfolios heading into yearend, it would be best to realize gains that can be applied to any available losses. Alternatively, your clients can realize losses by selling investments that have declined in value and use those losses to offset any gains.

“I am a firm believer in selling securities in a loss position,” Tew says, adding that there are many ways of getting exposure to replace losers.

“Clients can use accrued losses on investments,” Korenblum adds, “to shelter capital gains realized this year and in the previous three years to reduce their tax liability.”

Also, any net capital losses incurred in prior years can be carried forward indefinitely, Korenblum says: “If your client has loss carry-forwards and his or her portfolio has accrued gains, the client should consider taking some money off the table now and applying any current-year or prior-year losses to the extent available.”

If your clients choose to sell securities to realize a profit, they should consider waiting until the new year to make the sale, says Tim Cestnick, president and CEO of Waterstreet Family Offices, a division of 1832 Asset Management LP, in Toronto. This way, Cestnick says, clients will defer paying any taxes on the gains by a full year – that is, until April 2016 if securities are sold in early 2015. “Generally,” he adds, “paying taxes later is better than sooner.”

Cestnick notes that donating securities that have appreciated in value to a registered charity can eliminate the taxes due on the capital gain while also allowing a client to receive a donation credit.

“If your client donates shares of a public company,” Korenblum agrees, “they may be eligible for a 0% inclusion rate on any capital gain realized on the transfer. And, depending on your [client’s] province of residency and the amount donated, they can receive tax relief for 40% or greater of the value of the gifted security.”

Cestnick adds that your clients can elect to pay taxes on capital gains over a period of as long as five years by claiming a capital gains reserve. To do so, he says, clients can sell or transfer a security that has appreciated in value to an account held by their spouse. The market value of the security becomes the cost to the spouse, who can sell that security right away at market value. The spouse then issues a promissory note to your client, agreeing to pay for the security over a period of five years, which allows your client to defer taxes on the gains over the agreed-upon period. (Cestnick suggests using a professional to execute this strategy.)

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