How To Calculate Capital Gains And Adjusted Cost Base (ACB)
Capital gains are profits you earn through buying and selling capital assets. These include, but are not limited to, stocks, mutual funds and bonds.
In the US, the IRS estimated that it was losing $11 billion per year in tax revenue by taxpayers misreporting their capital gains. As a result, in 2011 they implemented new requirements for brokerages to track and report adjusted cost base (ACB) to investors and to the IRS.
Related: Dividend Tax Credit Explained
The Canada Revenue Agency (CRA) has no such requirements and since Canadian brokerages do not provide investors with complete details on capital gains on T3 or T5 slips, the onus of tracking ACB falls to the investor.
Purchases and Sales
The adjusted cost base of a security for tax purposes is its cost. ACB is tracked for each group of identical properties owned by an individual, e.g. shares of the same corporation, even if they are purchased on multiple dates or held in separate accounts.
Dividend payments don’t affect your capital gains tax unless they are reinvested, i.e. DRIP. The ACB is cumulative until all units are sold.
Related: How To Set Up A DRIP
Here’s an example:
On January 10, 2012 you buy 100 shares of X Company for $63 a share. On May 8, 2012 you buy an additional 60 shares at $72 a share. On September 28, 2012 you sell 50 shares at $75 a share. You pay a commission of $10 per transaction.
- Your initial ACB (January) is $6,310 – 100 shares purchased at $63 plus $10 commission.
- In May your ACB increased to $10,640 – $6,310 plus $4,330 (60 shares purchased at $72 plus commission).
- In September your ACB decreased to $7,315 – $10,640 minus ($10,6450 X (50 shares/160 shares) = $3,325
You incur a capital gain of $415 – 50 shares sold at $75 a share minus $10 commission minus $3,325 (see above calculation).
Return of Capital
Some funds or income trusts such as REITs distribute a portion of your capital with your income. This is called Return of Capital. This amount will be reported on your T3 slips.
Related: Are REIT’s Worth A Look For Yield Hungry Investors?
Return of capital reduces the total ACB by the amount of the return of capital. It will increase your capital gains (or reduce your losses) when the shares are sold.
Example of calculation:
On January 21, 2011 you buy 1000 shares of YREIT at $8.37 per share. In 2011 YREIT distributes .42237 cents per share as a return of capital. On January 30, 2012 you sell all your shares for $11.58 per share. You pay $10 commission on each of your transactions.
- Your initial ACB is $8,380 – 1000 shares at $8.37 plus $10 commission.
- The return of capital decreases the ACB to $7,957.63 – $8,380 – (1000 shares at .42237 cents per share).
Your capital gain in 2011 is $3,612.37 – (1000 shares at $11.58 per share minus $10 commission minus $7,957.63).
Mutual funds and ETFs
If you hold mutual funds and/or ETFs in a taxable account you will receive T3 or T5 slips.
Related: Mutual Funds vs. ETFs
There are two sources of capital gains:
- Internal capital gains – These are a result of trading within the account by fund managers. These gains are reinvested. You simply transfer the amounts from each box on your T3 or T5 slips onto your tax return. (Note that under Canadian tax law, net losses can’t be distributed to investors.)
- Gains from buying and selling – This is trickier to calculate correctly, especially if you’re on a purchase plan.
Use this formula:
- Total amount paid to purchase shares/units
- Minus any fees and commissions
- Plus reinvested distributions (only at year end)
- Minus any return of capital
Adjust the ACB every year you own the security.
Final Thoughts on Capital Gains and Adjusted Cost Base
Maintaining the ACB and calculating capital gains for a large number of securities can be tedious and time consuming, especially if you have stock splits and reinvested dividends. You may want to use a spreadsheet or personal finance software to keep track of this information.
One tool is www.adjustedcostbase.ca.
You should also retain any statements and trade confirmations as a backup.
There are no capital gains (or losses) on tax deferred (RRSP) or tax exempt (TFSA) accounts.
Understanding how your investments are taxed will allow you to plan a better investment strategy.
As you mentioned, if you re-invest your dividends through a DRIP it can make the ACB really complex (if you don’t keep a written record of each transaction) especially if you do this for 20+ years.
Luckily, the government has decided, for now, that if you donate shares to charity, you do NOT have to pay capital gains tax, although you do get a tax receipt for the current value of the stock.
So if you are helping to wrap up a large estate and the person who died owned shares that were in a DRIP for a long period of time and the person did not keep track of the ACB, you may want to consider donating the shares to charity. Sometimes the value of the charitable donation credit is enough to make this a good option vs the time of working out the ACB and the cost of paying the tax payable on the capital gain.
@Bet Crooks: Thank you for making this suggestion. It’s a very good point.