Tax-Efficient Investing: A Beginner's Guide to Taxes and Your Investments

Not all investments are created equal, at least, not when it comes to taxes.

When you’re an investor, you always want to make sure that you’re making the most return on your investments. Properly setting up tax-efficient investments makes it easy to save money where it counts.

This beginner-friendly introduction to tax-efficient investments will cover the basics of minimizing how much you’ll owe when filing your taxes.

Key Takeaways

Different types of investment income like capital gains, dividends or interest get taxed differently.
Investing with tax-advantaged accounts like a TFSA or RRSP helps you save on taxes.
Foreign investment and cryptocurrency investments are considered taxable and should be reported on your income tax return.

Why is tax efficiency important when I’m investing?

Investments, aka capital property, come in different shapes and sizes, including cottages, land, buildings, bonds, and stocks.

Depending on where you’ve invested your money, you’ll quickly find that different types of income get taxed differently. On top of this, how you’ve invested your money is also important. Even the type of account you use to make investments can reduce how much taxes you need to pay each year on any returns you make.

Learning how to be tax-efficient when you invest can help you grow your money and minimize how much taxes you have to pay, which means more money in your pocket.

When do I have to pay taxes on my investments?

Depending on the type of investment you’ve made, you may have income to report and taxes to pay each year. Keep in mind however, when you decide to sell a second property, stocks or any other capital investment for a higher amount than what you paid for it, you’ll need to report those profits as capital gains and pay taxes during the year you sold them.

What types of accounts can I use to save on taxes?

Do you want to minimize how much tax you pay on your investments? If so, using tax-sheltered or tax-advantaged accounts, like a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP) is a great solution.

With an RRSP, you deduct your contributions when filing your taxes, which reduces your taxable income. Only when you withdraw money from your RRSP, will you have to pay taxes on these amounts.
With a TFSA, any returns on investments made in a TFSA are tax-free. This means you can grow your money without having to pay taxes on your gains.

What are capital gains and how are they taxed in Canada?

Any time you invest your money into something that grows in value, that increase is considered a capital gain. These investments could be profits on sales from shares, mutual funds, and even real estate. You are taxed on 50% of your total gain.

You can use this simple formula to calculate your capital gains:

Amount earned from capital sale – (amount spent on capital purchase + other expenses) = capital gain

For example, if you bought 100 shares for $20 each, and then sold them a year later at $25 a share with a $200 sale fee:

$2,500 – ($2,000 + $200)

$2,500 – $2,200 = $300

This means you’ve made capital gains of $300. Of this, 50% (or $150) is taxable and will be added to your income.

What are dividends and how are they taxed?

When you invest in stocks, you might earn dividends, which are regular payments the company makes to its shareholders to share profit.

Here’s what you need to know about dividends and your taxes:

Companies designate their dividends as either eligible dividends or non-eligible dividends, which are taxed differently.
Both eligible and ineligible dividends have a gross-up rate that you must include on your return. A gross-up is an additional amount included to account for any taxes.
If you own stocks in a Canadian company, you may be eligible for the Federal Dividend Tax Credit.

Dividend-based investing can be a good way to reduce the amount of taxes you pay on your investment earnings since you can claim the dividend tax credit that reduces your taxes payable.

Do I pay taxes on interest-based income?

Yes, if you earned interest from a bank account, a guaranteed investment certificate (GIC), a term deposit, or bonds throughout the year, you’ll need to pay taxes on it.

Interest income is the least tax-efficient type of investment income. You are fully taxed on any interest earned. Even if you roll over your interest, you must include it as taxable income. For that reason, consider holding interest income in a tax-sheltered account like your RRSP or TFSA to maximize your tax savings.

What if I lose money on my investments?

Sometimes your investments might not do as well as you’d hoped. If this is your situation, what can you do?

There are a few options:

Luckily, the CRA lets you use your capital losses to offset any capital gains you make. This means you’re effectively claiming less of your gains as income, and paying less tax on it as a result.
Using capital losses to offset your capital gains is a key part of being tax-efficient, so it’s a good idea to be on top of how your investments are doing. When the time comes to file, you can leverage them to make sure you’re paying the least amount of tax possible.
Even investments into property that you purchase for a business can result in losses, since materials, machinery, software, and even office spaces can lose value over time. As a result, you can claim a Capital Cost Allowance (CCA) towards your business properties to offset this.

Do I pay taxes on foreign investments?

In Canada, the earnings you make from foreign investments need to be reported as income when filing your taxes, with the amounts converted into Canadian dollars.

Any foreign investments over $100,000 you have need to be reported each year when filing, even if you haven’t sold them yet.

If you have been charged tax by the country where you sold the investment, you may be able to avoid double taxation through the federal foreign tax credit.

Do I need to report my cryptocurrency gains and losses?

Cryptocurrency like Bitcoin and Ethereum might not be as straightforward as Canadian dollars, but the CRA treats crypto the same when it comes to reporting capital gains and losses. So, even though crypto transactions can be anonymous, you’re still required by law to track and report your transactions each year when filing your return.

Three strategies for tax-efficient investing

Learning how to make tax-efficient investments can help you keep more money in your pocket when filing your taxes. Here’s a breakdown of our top three recommendations on how to maximize your tax savings when investing:

Aim for eligible dividends: Investing in specific eligible dividends from Canadian organizations can automatically reduce the tax you’ll pay due to the lower rates. While both eligible dividends and non-eligible dividends can be a good investment, it’s a good idea to invest in companies that issue eligible dividends if you can to get a bigger tax break when filing.
Use CCA and capital losses to offset your capital gains: Claiming capital cost allowances (CCAs) and capital losses from investments that lost money are key to offsetting how much you pay on your profits. Remember, both of these can be carried forward to offset gains in later years as well. So even if you haven’t used them now, you can use them later.
Use tax-advantaged accounts to save money before you invest: Serious investors should understand the importance of placing their investments in the right accounts. Using TFSAs and RRSPs are a great way to let your savings grow tax-free (RRSP) or tax free (TFSA) and maximize your earnings in the long run.

Tax-Efficient Investing: A Beginner’s Guide to Taxes and Your Investments