Capital losses in RRSPs

A healthy income and a commitment to saving from a young age can put you in a very good financial position early on. But committing to saving without fully understanding how your investments work can leave you with unexpected — and unwanted — financial news.

RRSPs, for example, have many benefits, but relying solely on RRSPs for your savings strategy overlooks their drawbacks.

John Campbell, tax group leader with Hilborn in Toronto, says financial institutions have done a good job selling the positive benefits, such as the immediate tax savings, of an RRSP contribution, but don’t always explain the downside.

Funds can be transferred in and out of different investments within an RRSP without incurring a taxable event, but those same gains or losses can’t be used to offset gains or losses outside the plan.

And, transfers out of the RRSP must be made to another RRSP or RRIF or they will trigger tax.

Take the example of Josh, a 35-year-old single software designer living in London, Ontario, who recently discovered this.

The situation

Ever since Josh got his first paycheque from a part-time job, he’s been investing in registered accounts. With at least three decades to go before retirement, Josh’s RRSP portfolio is invested in global mutual funds, commodity stocks and specialty funds. Through diligent saving, he has managed to put away $110,000.

His $70,000 annual salary covers his mortgage and all living expenses. In addition, he inherited his grandmother’s house four years ago, which he’s been renting out at a rate that covers property taxes, utilities and upkeep.

His grandparents bought the property in the 1950s for $15,000, and it’s now worth $300,000 because of the size of the lot and its proximity to Western University.

The city now wants to acquire the property to build a parking lot, so he’ll face a significant capital gain. His RRSP investments have dropped, and he has a significant capital loss on paper. Josh wants to offset the capital gain with his RRSP capital losses.

The issues

So far this year, his RRSP investments have lost approximately $35,000. Josh also has about $25,000 in a savings account, and contributes to a defined-contribution pension plan, but has no non-registered investments.

He’s facing a significant capital gain when the city expropriates his house. The estate paid the initial capital gains when he inherited, but the house has since increased $50,000 in value. He needs to minimize the tax hit and also revamp his investments going forward.

The Solution

Josh can’t use his capital loss in the RRSP to offset the capital gain he’s facing, but he can rebalance his investment portfolio to prevent similar incidents from occurring. Within the registered portfolio, he can sell the stocks and purchase interest-bearing investments without triggering tax.

Claudio Piron, senior investment advisor with HollisWealth in Vaughan, Ont., says, “What happens to investments inside an RRSP is meaningless from a tax standpoint because they do not receive preferential tax treatment.“While he can’t use the capital loss in the RRSP to offset the capital gain from the real estate transaction, he might be able to negotiate with the city to defer the capital gain hit by paying him the proceeds over four years, rather than in a lump sum.”

He adds, “It would spread the impact.”