When you start investing, the first investing tax you need to understand the impact of your capital gains or capital loss on your income tax. At its core, the income tax on capital gains is pretty simple but I am not a tax expert and you may want to consult a tax expert.
Once a year, during the income tax season, you have to look at your investments and calculate your capital gains and losses to report them. It should not be too hard to manage and I have developed a spreadsheet to help keep track of it too. It’s especially useful if you have multiple purchases over time aggregated against only sell.
Tracking Your Capital Gains (or Losses)
As you may expect, your ability to accurately report your gains (or losses) is based on your tracking ability of all your transactions. Discount brokers provide you with a transaction statement for the year but it doesn’t do the tracking for multi-year transactions. That’s all on you. The challenges come with the fact that you may have purchased the shares 20 years ago … Did you keep track of it? What’s your ACB (Average Cost Basis)?
Capital Gains and Dividend Tracker – Also known as tracking your ACB.
Capital Gains Explained
Let me start by explaining what a capital gain is. In short, the money you make from your shares is called capital gains and the money you lose is a capital loss.
For a more detailed explanation … When you purchase 100 shares in company A for $10 each, you have invested $1,000 plus the transaction fee. When you decide to sell the shares at $12, you then receive $1,200 for the proceeds minus the transaction fees. Your capital gain is your proceeds minus your cost.
- $1,000.00 = 100 shares @ $10
- $9.95 = transaction fee
- $1,009.95 = full cost of purchase
- $10.0995 is essentially your per share cost
- $1,200.00 = 100 shares @ $12
- $9.95 = transaction fee
- $1,190.05 = proceeds from disposition
Capital Gains (or Losses)
Your result now depends on this last simple math equation :)
- Share Proceeds – Share Purchase = Capital Gains (or Losses)
- $1,190.05 – $1,009.95 = $180.10 in capital gains
- A negative number represent a capital loss
Feel free to look at the Canada Revenue Agency’s (CRA) information on the topic.
Income Tax on Capital Gains
Capital Gains Tax Rate
The income tax on your capital gains is calculated on 50% of your profit, also known as the inclusion rate. Because of the 50% inclusion rate, capital gains have a preferred income tax rate. The formula for your final income tax is the following:
Income Tax = Capital Gains * 50% * Marginal Tax Rate
The standard tax software out there will mostly be tracking your capital gains through your share transactions and will aggregate all your gains or losses to report your final capital gains in the proper tax form and all the math necessary will be calculated for you but it’s always good to know what the formula is.
If you happen to sell your shares in a currency other than Canadian, you will need to report profits from the currency exchange. In the case of a loss, you want to remove it from your capital gains.
The CRA has a very generic rule for reporting currency exchange but as you can see in my ACB tracking sheet, I like to track my currency exchange based on the exchange rate on the day of the transaction. The Bank of Canada makes it easy for investors to get access to the exchange rate – use the Bank of Canada currency converter for the rate of that day.
Be careful with the superficial loss. If a transaction generates a loss that you apply for the tax year but re-purchase shares from the same company within 30 days, you cannot apply the capital loss for the year. You can use the transactions in calculating your ACB but you cannot use it as a capital gains deduction
Capital Gains Income Tax Summary
In summary, you only have a couple of bookkeeping items to do for every transaction during the tax year (the calendar year).
- Track all your share transactions (Technically, you only need to track those in your non-registered account)
- Include your currency conversation per transaction (or as approved by the CRA)
If you happen to have capital losses, you can use them against capital gains. There are certain rules for applying them to past capital gains but you can also retain them for the future. The rules can change from year to year so make sure you follow up with a tax accountant when trying to make use of capital losses outside of the current year.
Note that any capital gains incurred inside a RRSP, RESP or TFSA is ignored. Withdrawing money from those accounts have their own rules.