It’s tax time again and reading some of the posts on various financial chat boards has led me to a conclusion: There are quite a few people who invest first and then try to figure out their taxes second. This isn’t the best idea for many of us. So my suggested rule is: ”Don’t buy investments which can earn taxable capital gains (or losses) unless and until you know how to calculate an Adjusted Cost Base, ACB.”

And I’d continue that rule with “Especially if you intend to use a Dividend Reinvestment Plan, DRIP.”

Why It May be Simpler for Beginners to Invest in a TFSA or RRSP

Investing in registered accounts is quite different than investing in non-registered accounts has some drawbacks:

• Investing in a TFSA or RRSP means that you will not be able to claim any Capital Losses on your income tax return. So if the value of your stock, ETF, or mutual fund drops between when you bought it and when you sold it you will not get any tax break for that lost money.
• [If you invest in a non-registered account and you suffer a Capital Loss, you can use it to “cancel out” a Capital Gain. This reduces the amount of tax you need to pay on a Capital Gain.]
• Also, counter intuitively, it’s not great to make a profit by selling your stock, ETF or mutual fund in your RRSP. If
• If you make a Capital Gain by selling an investment in a non-registered account, you only pay tax on part of the profit [currently 50%.]
• Fortunately, If you make a Capital Gain in a TFSA, you get to keep all of the profit tax free.
• If you make a Capital Gain in your RRSP, when you eventually take the money out of your RRSP/RRIF in the future, it will be taxed as if it is regular income. You will pay tax on the entire profit. [Note that part of that investment and profit really belongs to your “silent partner” the CRA.]

For many beginning investors it may be preferable to buy stocks, ETFs and mutual funds in a TFSA or RRSP rather than in a non-registered account. That’s because you will have to report all Capital Gains and Capital Losses for investments held in a non-registered account on your annual income tax forms. To report those gains and losses you will need to know the Adjusted Cost Base for your investment.

Do you?

T3 and T5s Lull Unsuspecting Investors Into Expecting a Tax Form for Everything

If you invest in a GIC in a non-registered account, you get a T5 from your financial institution telling you how much interest income to report on your taxes.

If you invest in a mutual fund or ETF in a non-registered account, you usually get a T-slip (T3, T5, etc.)  that tells you how much to report on your taxes for any interest paid, dividends paid (eligible and non-eligible, grossed up and straight), return of capital, capital gains and capital losses.

If you invest in a stock in a non-registered account, you often get a T-slip (T3 or T5 etc.) that tells you what dividends (eligible and non-eligible, grossed up and straight) to report.
This leads many new investors to assume that someone else will provide them with a helpful form telling them exactly what to report on their income taxes for all situations.

Unfortunately, that isn’t what happens.

How Do I Know What Capital Gains or Losses to Report on my Income Tax?

When you sell your stock, mutual fund or ETF, you will most likely sell it for at least a few cents more or less per share or unit than what you paid for it. That means you have to report your Capital Gain or Loss on your annual income tax. Do you know how much to report?

But, you may say, they reported my capital gain or loss on the slip I got for my mutual fund or ETF.

Did they?

One thing that definitely is reported on your T-slip is the capital gain or loss that occurred *within the mutual fund or ETF during the year. What I mean is, the manager of your mutual fund or ETF probably bought and sold some shares of the companies held by the fund. When that manager did so, the fund incurred a capital gain or capital loss. Because the fund itself pays no taxes directly, those gains and losses flow through to the investors who then have to claim them on their income tax returns.

Did your institution also report the Capital Gain or Loss from your sale of the asset?

I suppose it is possible that a financial institution will also report to you the capital gain or loss you incurred by selling your shares or units. But it does not have to report this to you, nor is it necessarily capable of reporting it correctly.

For example, if you bought shares at BMO InvestorLine, then transferred them to RBC Direct Investing, then RBCDI will not necessarily know what price you paid when you bought them. In they don’t, they can’t possibly issue you a correct T-slip for the gain or loss.

For another example, in the past I owned some shares of a company which were so old I had the paper share certificates in my safe deposit box. Through a strange coincidence, I came to be working for that same company. I was paid some additional shares in that company through a company savings plan program. When I sold the savings plan program shares, I could not just claim the capital gain on those particular shares. Instead, I had to calculate my adjusted cost base on all of my shares of the same company, then calculate the capital gain (which was unfortunately much higher) on the few shares that I sold, and pay tax on that higher capital gain.

The financial institution managing my savings plan program could not have reported an accurate capital gain to me on a T-slip  because they had no way of knowing that I held more identical shares of that company in another non-registered account.

Couldn’t I just have cheated and not used the real ACB when calculating my capital gain?

Ha, ha, ha, ha, ha. No.

I have absolutely no interest in trying to cheat on my taxes whether I am likely to get caught or not. And since the government does get official reports of the dividends I received for the shares in my safe deposit box each year, frankly, I would get caught.

So as I’m trying to show by use of these examples, in general brokerages will not report the capital gain or loss from the sale of your asset.

You Must Track Your Own Assets and Their ACBs to Calculate Your Capital Gains and Losses

There is no easy out. You really do have to track your own investments and all of the expenses you incur managing those investments if you hold stocks, mutual funds or ETFs in a non-registered (trading) account.

If you don’t know how to do that, learn *before* you start investing!

I’ll try to write some articles explaining what you may need to do.

In the meantime, you can start reading the information on the CRA website about Capital Gains. Or order their booklet to read, highlight, doodle on, and read again. It’s free.

• T4037 Capital Gains 2013
• Ordering publications from the CRA

Related Reading

• How to Buy Shares in a BMO InvestorLine Account

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Did you, or someone you know, make the mistake of not tracking their investments and then have conniptions trying to figure out their ACB and Capital Gains? Please share your experiences with a comment.