Tax Preparation 2018

As 2018 winds up, it is time to think about investment taxes and other financial housekeeping once again.

For the purposes of this post, make sure you complete any transactions no later than December 27, 2018 for them to settle in the 2018 tax year. If you execute the trade after this date, the tax gains or losses will apply in 2019.

Also, many of the investment taxation issues apply only to non-registered accounts. If your money is solely in a TFSA or RRSP, you don't need to worry about investment taxes.

However, if you are withdrawing from a TFSA or RRSP this year you will want to pay attention.

Re-balancing Portfolios

Given the market gyrations of 2018, you are likely to give some great opportunities for re-balancing and taking some tax losses.

Remember, in Canada capital losses can be carried forward indefinitely to offset future capital gains. They can also be used to offset capital gains already paid in the 2015, 2016, or 2017 tax years.

Leveraged Barbell Portfolios

If you are tracking one of the leveraged barbell portfolios which I share on this blog, you are likely to be down on a capital basis on your leveraged equity ETF (UPRO, SPXL, or HSU.TO) for this year.

If that's the case and you are investing in a non-registered account, it could be advantageous to book the loss now. To avoid superficial loss rules, you could buy a small cap leveraged ETF instead (URTY or TNA, for example). You could also buy the emerging markets leveraged ETF, which has dropped significantly this year (EDC).

Given the rise of interest rates this year, you are probably down on your bond holding as well. Again, if you are investing in a non-registered account consider booking the loss and buying a similar, but different bond ETF instead. For example, you could sell BSV and buy VGIT.

Make sure you re-balance correctly to your target allocation. Unless it is in your plan and you've carefully thought it through, do not increase your risk.

Couch Potato Portfolios

This year was an interesting year for Couch Potatoes as well. If you follow the standard CCP model ETF portfolio, you are holding XAW.TO, VCN.TO, and ZAG.TO as recommended by Dan Bortolotti.

Every one of these holdings are down for the year. Depending on when you started following CCP, you could have a capital loss on all of your holdings.

To book the losses and avoid the superficial loss rule in non-registered accounts, you could:

  1. Sell XAW.TO (which tracks MSCI Indices) and replace with VXC.TO (which tracks similar FTSE Indices);
  2. Sell VCN.TO (which tracks the FTSE Canada Index) and replace with XIC.TO (which tracks the S&P/TSX Capped Composite Index); and
  3. Sell ZAG.TO (which tracks the FTSE TMX Canada bond index) and replace with VAB.TO (which tracks the Bloomberg Barclays Canada bond index)

Regardless of taxes, the end of the year is always a great time to re-balance your portfolio back to your target allocation. Canadian stocks in particular have dropped quite a bit this year and should be topped up if you're following this strategy.

Tax Loss Harvesting

If you are investing in a non-registered account, now is the time to re-evaluate all your holdings and determine if you really want to keep them.

Many securities have declined quite drastically this year and, if they no longer fit in your portfolio, it is time to book the capital loss and use it to offset prior year, current year, or future capital gains.

If you like the current exposures you have, but you still are holding positions with a sizeable loss, you should consider selling anyways, booking the capital loss, and replacing the holding with a similar but different asset.

This could mean selling one energy asset for another, replacing gold (GLD) with silver (SLV), replacing BMO Bank (BMO.TO) with CIBC (CM.TO), and so on. Almost every asset on the market has very tight correlations with another asset.

Tax Gain Harvesting

In a prior post, I have gone into depth about the benefits of strategically harvesting capital gains in non-registered accounts when you are in a low tax bracket.

Unlike capital losses which are subject to the superficial loss rule in Canada, you can legally sell an asset, or part of an asset holding, for a gain and then repurchase the same asset immediately.

Doing this carefully at low capital gains tax rates can steadily increase your adjusted cost base and significantly reduce future tax liabilities.

This strategy is best done when you are not earning other income, such as employment income or RRSP withdrawals.

Ideally you want to realize capital gains when you are in the lowest tax bracket and you can offset the realized income with interest expense or other tax deductions.

Spousal Loans

Although the CRA prescribed rate has crept up this year, you can still make a spousal loan for just 2 percent annual interest.

Spousal loans can be a very tax friendly strategy for moving assets from a high income, high wealth spouse to a lower income spouse. Here are the steps to do this:

  1. The high income spouse writes a legal contract with the low income spouse for a loan meeting the conditions required by the CRA;
  2. They transfer the loaned money to the low income spouse;
  3. The receiving spouse invests all of the money in a non-registered account, buying income generating assets like stocks which pay dividends;
  4. The receiving spouse pays their partner the necessary interest payment at the end of each year, but can deduct that expense from their income at tax time as it is an investment loan;
  5. The high income spouse must claim the interest income and pay taxes on it.

In this strategy, the high income spouse moves their wealth to the low income spouse via a legal contract. They get some taxable interest income, but at a 2 percent rate it is very minimal.

The lower income spouse gets almost all the wealth growth and pays much less tax on this wealth growth than the higher income spouse would if they had invested the money themselves.

In most cases this strategy should only be considered for individuals who have already filled their registered accounts, have a meaningful amount of excess money to loan to their spouse, and their spouse earns significantly less income.

TFSA Contributions or Changes

A few weeks ago, the government has announced they will be increasing the TFSA contribution amount to $6,000 for the 2019 year.

This means a couple will be able to invest $12,000 in their TFSAs and grow that money forever, but pay no taxes on the wealth growth.

If you're really rich, you can also put money into an adult child's TFSA, provided they earned some money and file a tax return.

Try to fill your TFSAs as soon as you can. You might need to transfer money from your non-registered account but, if you do this is January, you won't pay taxes on any realized gains for nearly sixteen months. Of course if you have capital losses you can realize, take them in 2018.

Moving Your TFSA

If you've been thinking about moving your TFSA to a new brokerage, now is the time to plan this carefully to avoid pesky over-contribution rules and penalties.

  1. Complete the paperwork to open a new TFSA account at your desired broker. I like Questrade and National Bank Direct for registered accounts—they each have their own advantages for different situations;
  2. Withdraw all the money from your existing TFSA account before the end of December, close the account, and hold the cash in your personal chequing account; and
  3. Deposit the money into your new TFSA account in the beginning of January.

You should be able to move TFSAs without incurring any fees aside from some trading commissions if they apply.

Always check first, but most good banks do not charge fees to close TFSA accounts. If they do, you could just keep them dormant forever with a few pennies in the account.

RRSP Housekeeping

Get ready for so-called "RRSP Season" which runs from January through the end of February. During this time you can make RRSP contributions and apply them against your 2018 income—saving you money on income taxes.

Unless you expect a significant pay raise in 2019, try use your RRSP room as soon as possible. This is especially true if you earn over $93,208 in 2018. There's no point in running a big tax credit with the government—they charge interest, but they don't pay it.

If you are retired, were a stay-at-home mom, took a sabbatical, or experienced a temporary loss of income, consider making RRSP withdrawals to take advantage of low tax rates.

As I often state on this blog, I am a big proponent of what I call "tax-targeting". Try realize as much income as possible at a reasonable tax rate given your personal situation.

If you can realize income at an overall tax rate of 10 percent, take advantage of the opportunity! You can use the withdrawn money to fill your TFSAs, non-registered accounts, or even pay off debts.

Smith Manoeuvre

If you've implemented the Smith Manoeuvre, the coming weeks are a great time to get your paperwork in order, make sure the strategy is running smoothly, and make any necessary tax adjustments for RoC distributions.

Given the amount of paperwork and running around involved in establishing a proper Smith Manoeuvre process, this time of year could be a good time to get things arranged for a new Smith Manoeuvre.

Although you should anticipate pretty meagre future returns in many equity markets for some time, the Smith Manoeuvre is a long term process.

Also, the biggest benefit of the Smith Manoeuvre is the tax savings—which are substantial over time! These tax savings can help you save more and invest more, growing your overall wealth.

Interest rates are still very low by historical standards and can drop significantly if we enter another recession. With the U.S. Federal Reserve indicating they are coming to the end of rate increases, I think HELOC rates in Canada are also unlikely to increase much more.

Blog Stuff

The blog continues to grow, albeit more slowly than before. I have shifted a lot of my posts over to a more technical and advanced perspective designed for more experienced investors.

I understand this might fly over the head of the typical Canadian who continues to pickle themselves in debt, live paycheque to paycheque, and pray for ever higher house prices (if they own a house).

I'm making this shift intentionally as there are countless blogs out there which preach personal finance basics, push Couch Potatoesque investing, and try sell you credit cards or other financial products. My target audience is the more advanced investor who hopefully has the basics taken care of.

During 2018, readers have come to the site more than 16,000 times. You have read more than 35,000 pages and left over 300 comments.

Thank you and I hope you will continue to be engaged, ask questions, and give me things to think about.

I truly believe my own investing process is getting better because of the things I explore; much of it inspired by comments and emails I receive from readers.

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