Many experts and analysts are bracing for lacklustre returns in 2023. If you are an investor, you may sell some of your investments and trigger capital losses as you rebalance your portfolio. In this article, we outline some tax strategies that can go hand-in-hand with your investment decision that will put more money into your pockets.
Utilizing capital losses to maximize a tax refund
Capital losses can only offset capital gains. If you don’t have capital gains to offset using capital losses, you can carry forward the capital losses indefinitely or carry them back 3 years, and offset capital gains, to reduce taxes.
You have a choice in this. Therefore, in an ideal world, you would want to use up the losses in a year you were in a higher tax bracket because every dollar would mean more tax savings. You get more bang for your buck.
If you expect to be in a higher tax bracket in the future and expect to have capital gains, it may make sense to carry the capital loss forward. However, in most cases, people don’t have the benefit of hindsight and carry their capital losses back to one of the three previous years.
If you are triggering capital losses, speak to your accountant about possibly utilizing the capital loss to recover the most taxes.
Preserving the Capital Dividend Account when you have capital losses
In Canada, you only pay taxes on 50% of capital gains, whether you earn it directly or through a corporation. If you earn capital gains inside a corporation, the corporation gets a credit to the capital dividend account (“CDA”) equal to 50% of the capital gain.
The corporation can pay out an amount accumulated in the CDA to its shareholders tax-free through a capital dividend.
The CDA is an accumulation of all the capital gains and capital losses. Capital gains increase the CDA, while capital losses reduce the CDA. Because of this, you must be careful when to trigger capital losses. Trigging a capital loss – selling your investments at a loss – before you pay a capital dividend could lower your CDA balance.
For this reason, it is wise first to pay a capital dividend to reduce your CDA balance to zero and then trigger capital losses. If you end up triggering a loss first, then your CDA balance will go down, and you will not be able to pay as much of a tax-free capital dividend.
Before you sell your investments to trigger capital losses in a corporation, please ask your accountant whether it makes sense to clear out the CDA balance first.
Using a bad market to draw money tax-free from your company
A more fancy tax plan is often best when there is a lacklustre market.
You could consider selling investments – that you want to hold long-term – to your corporation in exchange for a promissory note. As you need money from the corporation, you can draw on the promissory note.
With a bad market, there should be little or no capital gains on which you must pay taxes.
With this strategy, you can accomplish the following:
- Extracted corporate funds at a low tax rate or for by paying no tax;
- Stayed invested in the investments you wanted to hold long-term but through a corporation.
With a tax strategy like this, there are many pitfalls to watch out for, and implementation is critical. For this reason, it is essential that you work with an experienced tax practitioner. We are happy to sit down with you and look at strategies like the above as you make key investment decisions for 2023.
