Five Tax Tips for Investors: Capital Gains, Foreign Investments and Charity

Structuring one's affairs to pay no more than the legal minimum amount of income tax is perfectly ok, as Canada's tax collector, the Canada Revenue Agency, states in the first point of the Taxpayer Bill of Rights in CRA's Making A Difference. To that end, here is a list of short and long-term tax reduction ideas for investors to consider and investigate:

1. Carry Back Capital Losses Against Previously Reported Gains - If you have losses that exceed current year capital gains (you must first use your losses against current year gains), you are able to offset previously reported gains for any of the prior three tax years and get a refund of taxes paid. TaxTips.ca explains in Capital Losses how to make the claim. The losses can also be carried forward indefinitely to offset future capital gains. Though all capital gains and losses must be reported on the tax return in the year incurred, it is worth considering past and future marginal rates - claiming the loss against gains saves most tax when marginal rates are high. If you neglected to report a capital loss thinking it did not matter at the time, it is still possible to file an adjusted return (using the T1-ADJ form) for past years and then to use the loss against gains today or in future.

2. Use Past Capital Losses Against Current Year Gains - Last year's Assessment Notice from the CRA will state the amount of any accumulated losses that can be used in the current tax return to offset gains.

3. Select A Favourable Exchange Rate for Reporting Income from Foreign Investments - The CRA allows a taxpayer to choose either the average rate for the year or the rate in effect on the day the income was received. The Bank of Canada publishes rates acceptable to CRA here. If the year average is much higher than the day income is received, the taxpayer ends up with more taxable income in Canadian dollars to declare, which means higher taxes. For instance, the 2009 average rate of Canadian dollars per US dollar was 1.141977 but the year-end rate was only 1.0510. If most of the foreign income came in with year-end distributions, using the year-end rate will produce less Canadian dollars to declare. One caveat is that the same method must be used for all investment income in a particular tax year.

4. Optimize Reporting of the Foreign Income Taxes Paid - When you receive foreign income in a taxable account, (e.g. dividends or interest from US investments), the foreign government deducts tax, usually 15% (the standard amount in international tax treaties). The 15% deducted can be claimed either as a Foreign Tax Credit or as a combination with a Line 232 "Other Deductions". Finding the exact best mix is a circular calculation only determined by trial and error but it can reduce Canadian tax you would need to pay. TaxTips.ca's Foreign non-business income tax and foreign tax credit explains how this works. CanadianFinancialDIY discovered last year that one of the tax preparation software packages TaxChopper performs this optimization calculation automatically.

5. Donate Securities In-Kind to Charity - If the securities have a capital gain, selling the securities and donating the cash to a charity will oblige you to pay a tax on the capital gain. Instead, transferring the securities in kind to the charity as a special tax rule exempts the gain from any tax, as noted in resolution 9 "Donations of Securities" of the May 2008 eMonthly newsletter from financial publisher CCH. The full market value of the donation is still eligible for the charitable tax credit. You can contact the charity to learn how to do this, or you can donate securities online through CanadaHelps.org.

Next week's post will outline special ways by which investor couples or families can minimize their taxes.

Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above are food for thought and are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Some strategies are more complicated and will not work if not carried out precisely in keeping with the tax rules. Do your homework before making any decisions and consider consulting a professional advisor.