They say a picture is worth a thousand words. In some cases, it may be worth millions. Two years ago, Christie's auction house in New York sold a photograph of the Rhine River by German artist Andreas Gursky for a record $4.3-million (U.S.). I'm not exactly sure, but I'm guessing it would have been cheaper to enjoy the same view by purchasing the actual waterfront property where the picture was taken. All I know, is that the owner of that photo made a substantial profit on its sale and probably paid a whack of tax.
Two of the biggest challenges facing any investor are how to minimize tax on capital gains – whether on artwork, stocks, real estate or other assets – and how to make the most of capital losses. As we approach year-end, consider these ideas for dealing with capital gains and losses in 2013:
Defer dispositions until next year
If you're thinking of selling securities at a profit in 2013, consider waiting until early in the new year to make that sale. This will push the tax bill on the capital gains into 2014 and your taxes for 2014 won't be due until you file your tax return in April, 2015. This will defer the payment of your taxes by a full year.
Step up your cost amount before year-end
The higher your adjusted cost base (ACB) – that is, the cost amount of your investments – the less tax you'll pay later when you sell. You can increase your ACB by selling securities that have appreciated in value and then reinvesting those dollars in the same or other investments. This can make good sense if you'll pay little or no tax on the capital gains today, perhaps because your income is low enough to be fully offset by the basic personal amount ($11,038 (Canadian) in 2013), losses or other deductions.
Offset gains and losses before year-end
If you have capital losses to use up, consider selling other securities at a profit before year-end to use those losses. Similarly, if you realized capital gains in 2013 and are expecting to pay tax on those gains, consider selling some other investments that have dropped in value to apply your losses against the gains. Keep in mind that the final day for trading, if you hope for a transaction to settle in 2013, is Dec. 23.
Claim a capital gains reserve
It's possible to pay tax on your capital gains over a period as long as five years. To claim a reserve, you must not be entitled to all of your sale proceeds in the year you sell the investment. If you collect your proceeds over two years, then you'll pay tax over two years, and so on, to a maximum five years. This can work well for sales of certain tangible assets, such as real estate, but can even work for sales of securities if you sell to a family member first who then sells on the open market. But speak to a tax pro about how to do this properly.
Claim the lifetime capital gains exemption
It's possible to shelter up to $750,000 in capital gains ($800,000 beginning in 2014) on qualified small business corporation shares or qualified farming or fishing property. There are ways to use up this exemption without giving up control of your business or assets today. Speak to a tax pro about it.
Donate securities to charity
If you donate securities that have appreciated in value to a registered charity, you can eliminate the tax on the capital gain, and receive a donation tax credit as well. It makes more sense than donating cash. Don't wait until the last minute to do this, however – the paperwork may take a couple of days.
Close out option contracts with accrued losses
If you close out option contracts with accrued capital losses before year-end, you'll be able to utilize those losses to offset realized capital gains this year, or in 2010, 2011 or 2012.
Give losing investments to an adult child
If you have investments that have declined in value, consider giving those to an adult child if you still like the future prospects of the investment. By doing this, you'll trigger a capital loss that you can use today or in the future, and you'll pass the future growth to your child to be taxed in his or her hands, not yours. This can reduce taxes and probate fees that might otherwise be owing at the time of your death.
Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books. tcestnick@waterstreet.ca
Tim Cestnick