- Benefits for contributing to an RRSP early
- Figuring out your adjusted cost basis
- Investing your tax refund
With this year’s taxes off to the CRA (at least we hope you have by now). There shouldn’t be much left to do except wait for your tax return (unless you’re part of the unlucky bunch that owe money, in that case, our condolences). Now here’s something you don’t want to hear. The 2020 tax season starts right now.
If you haven’t closed your browser window yet, hear me out. Preparing your taxes is time consuming and a little aggravating, but it doesn’t have to be. Especially when it comes to tracking the investment portion of it all. Doing a little work throughout the year can set you up for success. In this article, we’ll walk you through easy little steps to take to cut your tax time in half next year. So while everyone’s scrambling in April, you’ll already be done and getting on with your life.
Contribute to your RRSP throughout the year
RRSP season starts as the calendar rolls over but really amps up in February as Canadians have until March 1 to have their RRSP contributions eligible for the previous tax year. But this season is a relic of a non-digital age, when you had to line up to get your deposit in (remember that?). In our new digital world, there’s no reason why you shouldn’t be putting regular RRSP contributions in throughout the year.
Contributing throughout the year has two main benefits:
- Your money has more time to grow interest free. If you contribute regularly, your money will be tax-sheltered longer and more time for compounding to work its magic.
- You won’t have to pull your hair out trying to figure out how much you should contribute at the end of RRSP season. You’ll effectively put your retirement savings on auto pilot and have one less thing to worry about in your busy life.
Constantly adjusting your adjusted cost basis (ACB)
If you made money from your investments this year, good work!
But the bad news is you may have to pay taxes on the gain.
For people investing in non-registered accounts, you need to figure out how much you need to pay in capital gains tax. Capital gains tax must be factored into your taxes when you sell an asset or investment for more than you paid – with a percentage of the difference being added to your regular income. (If you actually had a loss from your investment, you can also deduct the loss from any capital gains tax you would pay. To do this, you also need to know your adjusted cost basis.)
For example, if you bought shares of a company for $10,000 and sold them for $15,000, you made yourself a nice $5,000 profit. Good work. You will have to declare this profit as income. Luckily you’ll only be taxed on 50% of the profit because as of 2018, the capital gains inclusion rate is 50%. So you would only have to add $2,500 ($5,000 x50%) to your total taxable income.
However, this calculation is rarely that simple. Investors usually buy shares at several price points, dollar-cost averaging to a better base price. So, to properly figure out the tax number, here’s how to calculate a more complex adjusted cost basis.
Calculating adjusted cost basis
To calculate adjusted cost basis, add the price you paid for your investment and divide it by the shares you own. You also need to make sure you’re including reinvested dividends, commissions and fees.
Say you buy 100 shares in a company for $10 each. Later, the stock price falls so you decide to buy 100 more shares in that company at $8 each.
And say you paid $5 in commissions per transaction. Your adjusted cost basis would be:
100 x $10 = $1,000
100 x $8 = $800
2 x $5 =$10
$1,000 + $800 + $10 = $1810
The total cost of your investment is $1,810.
Now you divide that amount by the 200 shares you own.
The result is an adjusted cost basis of $9.05 per share.
If the stock goes back to $10 and you sell 100 shares. (Again assuming $5 commission paid)
Total from sale: 100 x $10 = $1,000
Minus commission = $1,000 - $5 = $995
Net taxable gain = $995 – $905 ($9.05 ACB x 100) = $90
You made $90 on those 100 shares. Since only 50% of capital gains must be taxed, you would add $45 ($90 x 50%) to your income for the year.
For a more information on adjusted cost basis and the nuances that come with it visit the CRA
If you’re doing this at the end of the year it could be a nightmare. But keeping a spreadsheet with your adjusted cost basis throughout the year means this time next year you won’t be pulling your hair out.
Investing your tax refund
Now you did your taxes, and you’re hopefully about to get a big chunk of money back from the government. You’re thinking of the ways to spend this tiny windfall. What would really benefit you more than that new iPhone is reinvesting it back into your RRSP or TFSA.
While it won’t give you that hit of dopamine a new gadget will give you, it will do a lot towards getting you to a long-term goal. While retirement might be far away for some, the more savings you can accumulate early, the longer you have for compounding to take effect. Or maybe there’s more of a mid-range goal, like buying a house or cottage, or saving for a big trip. These are things that can take a big step forward with an infusion from your tax return.
No one likes doing taxes, but with these tips, you can help ease the burden of tax season next year. It’ll be here before you know it.
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The information in this blog is for information purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.