February 6, 2012 | In: General

How to Report Capital Gains on My Tax Return?

This Friday, I have received a scary letter from CRA (Canada Revenue Agency, which is the equivalent of the IRS in the US). The letter is not copyrighted and that’s why I’ll publish it here. Please note that I will include the letter in full but I will not include the name of the person at the end of the letter (e.g. the person who sent me the letter), as well as my personal information (that goes without saying). Without further delay, here is the letter:

Dear Sir:

Re: Your 2010 income tax and benefit return

Canada’s tax system relies on voluntary compliance and self-assessment. The Canada Revenue Agency (CRA) provides Canadians with the information they need to meet their income tax obligations.

Our records show that you disposed of securities held outside a registered retirement savings plan account. You would likely have received monthly, quarterly, or annual statement(s) of your account(s) and/or Canada Revenue Agency T5008 Statement of Securities Transactions slip(s) detailing disposition(s).

The purpose of this letter is to provide information about calculating capital gains or losses that arise from dispositions of publicly-traded shares or mutual fund units. See Appendix A, attached, for information on capital gains or losses.

If you find that your capital gains or losses are accurate, you don’t have to do anything. However, if you find that some amounts were incorrect or missing, you should ask the CRA for an adjustment within 30 days of the date of this letter.

To request an adjustment, complete Form T1-ADJ, T1 Adjustment Request, available at www.cra.gc.ca/forms or by calling 1-800-959-221. Instructions for completing form T1-ADJ are on page 2 of the form. You can also make changes to your returns online at www.cra.gc.ca/myaccount. You will need to log in and follow the steps.

More information about the CRA, such as the Voluntary Disclosure Program and available payment options, can be found at www.cra.gc.ca or by calling our individual income tax enquiries line at 1-800-959-8281. You can also consult our web page developed for this letter at www.cra.gc.ca/audit.

Thank you for your cooperation.

Note: The remaining pages of the letter explain how to calculate capital gains/losses on the tax return, which I will explain on this article myself. However, I think it’s worthy to mention this line from the Appendix A mentioned above:

If you do not report capital gains on Schedule 3, the CRA may take a second closer look at your tax return because brokerage and fund companies send us an electronic copy of all their T5008 slips.

In case you were not able to understand what the above statement means, let me explain it to you. CRA knows about every single trade that you make because all brokerage companies you deal with send them all the information they have about your trades. In other words, the CRA people already know how much you owe them even if you don’t report this information, they’re just giving you the benefit of the doubt though…

I went through several mood swings when I read the letter:

1 – Fear: I felt very afraid when I first opened the letter. I thought that I made a mistake in my tax return for 2010 and that the CRA discovered that mistake. Obviously the letter is related to my stock trading activities back in 2010 which I was sure I reported properly, but still, there’s always the chance that I might have missed something. I searched my (physical) documents for my 2010 tax return, and I found the documents sent to me by BMO (The Bank of Montreal) Investorline at the end of the year. There was a trading summary (listing every trade I made back in 2010, grouped by stock name), and there was another form, which was investment form summary (none of them looked like an official document that might be needed to report taxes), and the final document was called a T5 form, which was an official document and which I have already included in my tax return (it contained my Interest from Canadian sources in box number 13 (all Canadians know what boxes mean in the tax return). Now that I am sure that I have reported my capital gains in my tax return, my mood changed to…

2 – Relaxation: I became more relaxed once I knew that I’ve reported my capital gains on my tax return. And what gave me more comfort is the statement “if you find that your capital gains are accurate…”. Obviously, that was a generic letter sent to anyone who did stock trading in the year before. And because 2010 was my first year of stock trading, it was natural that I would receive such a letter at this time… At that point, I felt there was no need for me to worry and I can now go to sleep. And so I did, but the moment I have closed my eyes I moved to the next stage which is…

3 – Anxiety: I started thinking, why would CRA send me such a document? Is it really generic and is it really sent to anyone who did stock trading? And how come they mentioned the dreadful word audit in their letter. So I left the bed, and I re-read the document, as well as the attached form on how to report taxes on capital gains (or losses). It turns out that I have to report every disposition of shares that lead to capital gains (or losses) after accounting for the different broker fees (such as commission fees). Apparently, the bank should have sent me a form called T5008 (which I haven’t received) that contained all these numbers in organized format (so that I won’t have to do anything). At this point my mood changed to…

4 – Anger: I know that it’s my responsibility to report any income on my taxes, but I have expected the bank to facilitate the work on my behalf and provide me with the appropriate tax statements (with the appropriate boxes filled in). What the bank has provided me was literally 6 pages of small-font characters and numbers. These 6 pages contained all the trades that I made, the date that I made these trades on, the number/quantity of shares that I bought, my average fill price, and the total cost/disposition resulting from that trade. All the trades were grouped by the stock name. On the other hand, CRA wants all the trades that resulted from the disposition of shares, the average cost (or book price) per share, the number of shares disposed of, and the gain/loss resulting from the disposition of these shares. The information that the bank gave me can give me the information that the CRA need, but it does take a lot of time to do all the calculation by myself. I felt and I still feel very angry at the bank for not providing me with the information in the exact format that CRA needs. Is it that hard for them to develop a program that will calculate the average buy price (including the commission fees) of a stock, the number of shares that I have disposed of for that particular stock, the proceeds from the settlement of that disposition, and the capital gain/loss from that disposition?

Now, after the above rant, let me explain to how to report capital gains on your tax return:

  • Calculate your average cost per share (the so called “adjusted cost base per share”) the following way: Multiply the quantity of shares that you have bought for a particular stock by the average fill price of that quantity, and then divide the result by the total quantity. Let’s assume that you have done the following buy trades back in 2010 (note that all banks calculate-in your commission fees in the price/share):
    • Bought 20 shares of AAPL at $250/share.
    • Bought 20 shares of AAPL at $260/share.
    • Bought 20 shares of AAPL at $300/share.

    The “adjusted cost base per share” would be ((20x$250) + (20x$260) + (20x$300))/ 60 = ($5,000 + $5,200 + $6,000)/60 = $270. The formula is: ACB/share = (Σ (Total Cost of shares) + Σ (Total Commissions/Fees))/ Σ (Total Number of Shares). (Note that the formula is more complicated if you owned and partially sold shares of the same stock in previous years(s)).

  • Calculate your adjusted cost base. Let’s say that you have sold 40 shares of AAPL. Your adjusted cost base will be 40 x $270 = $10,800.
  • Calculate your capital gains. Let’s say that your 40 shares of AAPL had total proceeds of $11,280. This means that your capital gain resulting from the proceeds of this trade is: Total Proceeds – Adjusted Cost Base (ACB) = $11,280 – $10,800 = $480.
  • Go to line 132 of your schedule 3 form. Column 2 should contain the proceeds of your disposition (or $11,280), column 3 should contain your adjusted cost base ($10,800), and column 4 should contain commissions/fees that you incurred when selling your shares (this should be zero since all banks already factor-in the commissions and fees), and finally column 5 should contain your capital gains (or losses), which is $480 in our example above.

Now since I didn’t report my capital gains by following the above steps, I have to pay the penalty (for some reason I remember that episode where Daffy Duck was a host in a show called “Truth or Aaaaaa”. In that show every time the contester made a mistake, Daffy Duck used to tell him “I’m sorry, but you have to pay the penalty”. I think that episode was called The Ducksters). According to CRA, the penalty is 5%+ 1%/month which makes it about 17%. I don’t know if they have the heart to make me pay it or not yet (although I suspect they do). I’ll keep you updated…

This article (as well as all other articles on this website) is an intellectual property and copyright of Fadi El-Eter and can only appear on fadi.el-eter.com.

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