We keep hearing it from many of you - how much longer can the market (and your portfolio) keep climbing?climbing?
Jim has aptly coined the term “altitude sickness” to describe the mix of excitement and unease that comes when markets reach new highs. Over the coming weeks, we’ll share our detailed thoughts on where we see markets heading. But today, we want to step back and explain how we manage these risks and, more importantly, how we protect the value of your wealth when the time comes to take profits.
Admittedly, one of the most satisfying moments in investing is realizing a profit from a business we believed in. It’s tangible evidence that our investment process worked. But that success brings another important consideration: capital gains tax.
For those of you with taxable investment accounts - such as non-registered accounts, corporations, or most trusts - we’ll be reaching out in the coming weeks to discuss your realized capital gains for the year to discuss how you’d like to approach them at tax time.
To help you make an informed decision, here’s some background on capital gains and the strategies available to manage them effectively.
What Are Capital Gains?
A capital gain occurs when you sell an investment for more than you paid for it. For example:
If we invested $50,000 in the shares of a business and later sold it for $80,000, the $30,000 difference is your realized capital gain.
In Canada, only 50% of a capital gain is taxable, meaning half of your gain is added to your income and taxed at your marginal rate. So, if you’re in a 40% tax bracket:
$30,000 × 50% × 40% = $6,000 in tax
This 50% inclusion rate makes capital gains one of the most tax-efficient forms of income, whether realized personally or within a corporation or trust.
When Are Capital Gains Triggered?
Capital gains are only realized when you sell an investment. Simply holding an investment that has appreciated does not trigger tax.
This distinction between realized and unrealized gains forms the foundation of many tax-deferral strategies. Unrealized gains, often described your “paper” profits, are not taxable until you dispose of the asset.
“Make Hay While the Sun is Shining”
Our process is built around disciplined risk management. When the value of a business we own grows beyond our price target, we trim the position to lock in gains and rebalance risk.
When making this decision to “trim”, we often ask: Would we be more upset if we trimmed/sold and the stock kept rising, or if we held on and it fell? This mindset helps us protect your capital through changing markets.
How We Manage Capital Gains
1. Harvest Losses Strategically
Sometimes, the best way to offset a gain is with a loss. Selling investments that have declined in value can realize a capital loss, which may offset gains in the same year, carried back three years, or carried forward indefinitely.
This process, known as tax-loss harvesting, typically takes place late in the year, or earlier if an investment thesis simply doesn’t work out. We’re always mindful of the superficial loss rule, which disallows a loss if you (or your spouse or corporation) repurchase the same or an identical security within 30 days.
2. Donate Appreciated Securities to Charity
One of the most effective and gratifying tax strategies is donating shares in-kind of a business you own to a registered charity.
By doing this, you:
- Receive a charitable tax receipt for the fair market value of the securities, and
- Completely eliminate the capital gains tax on the donated shares.
Example:
If you purchased shares of Company XYZ for $10 and they are now worth $100, selling them would trigger a $90 capital gain. However, donating them directly to charity eliminates the tax on that gain and still gives you a $100 donation receipt.
You can apply the tax credit this year or carry it forward for up to five years.
For clients who donate regularly, or who wish to plan longer-term giving, a donor-advised fund (DAF) can be a great option. The RBC Dominion Securities Charitable Gift Fund allows you to create your own family foundation, providing flexibility to support your chosen causes while optimizing your tax planning.
This strategy can be especially powerful for business owners or individuals experiencing one-time taxable events, such as the sale of a company or property.
For those looking to make a donation this year using some of your appreciated investments, please contact direct us and we can help you do this. We would like to complete these donations by December 12th.
3. Set Cash Aside to Pay in the New Year
The simplest option: set aside sufficient cash in your account to cover your upcoming tax bill. We often allocate this amount into your low- or no-risk bucket, ensuring funds are ready when taxes come due.
***Capital Gains in a Corporate Investment Account
For incorporated professionals and business owners, capital gains interact with mechanisms such as the Capital Dividend Account (CDA) and Refundable Dividend Tax on Hand (RDTOH). As a reminder, half of a realized capital gain increases the CDA balance, which can be distributed tax-free to shareholders. A valuable planning opportunity when managed correctly. For example, if we realized $100,000 in gains in your corporate account, approximately $50,000 could be transferred to you personally tax-free. There are some nuances with this, so, refer to your accountant who tracks your CDA balance for more clarity on this.
In short, realizing gains within your corporation can actually help transfer wealth to you and your family more efficiently.
Final Thoughts
Managing capital gains is a natural and positive part of successful investing. Our focus is always to align with your overall wealth and tax strategy, but as we often remind clients: we don’t let the tax tail wag the investment dog. Our goal is to manage risk on the way up, protect capital on the way down, and ensure your portfolio continues to grow prudently and tax-efficiently.
As the saying goes, make hay while the sun is shining. Smart tax management isn’t about avoiding gains, it’s about turning them into long-term wealth.