Calculating tax on capital gains

[Shojin]

Ok... let's say I use a HELOC or secured LOC to borrow funds to invest in stocks that appreciate in value (capital gains).

Let's say R = rate of return, I = borrowing cost, P = amount invested.

How is the amount subjected to taxes calculated?

a) P * (R-I) / 2
b) P * [(R/2) - I]
c) something else altogether

This is assuming capital gains only.

On another note, how would capital gains + dividends be taxed?

Also, I plan to use a BMO ReadiLine to facilitate something like this.... the secured portion is at Prime. Anyone get better than this for a secured LOC?

[kaycee8877]

(cap gains x 50%) - (interest on LOC) x tax rate

cap gains at 50 % are added to income (plus taxable amount of dividends) ...plus all your other stuff .. then the interest on the LOC is deducted after your total income is calculated

the interest on the LOC is a seperate deduction .. 100% deductible (goes on your T1 schedule 4 as a carrying charge)

[Shojin]

Ah.. so option b) then.

As a simplified example, if I were to borrow $10,000 at 5% and invest it with a capital gains of 8%, it would be calculated as follows:

8% of 10000 = 800
Taxable portion of capital gains = 800 * 0.5 = 400
Deductable interest on loan = 5% of 10000 = 500

Taxable amount = 400 - 500 = -100. Hence no tax is payable?
Would my net return then be 800 - 500 = $300?

Also, does this mean I have an additional $100 I can deduct on other investments, or carry forward to deduct in later years?

[brandnew]

principal for our tax return.

Ah.. so option b) then.

As a simplified example, if I were to borrow $10,000 at 5% and invest it with a capital gains of 8%, it would be calculated as follows:

8% of 10000 = 800
Taxable portion of capital gains = 800 * 0.5 = 400
Deductable interest on loan = 5% of 10000 = 500

Taxable amount = 400 - 500 = -100. Hence no tax is payable?
Would my net return then be 800 - 500 = $300?

Also, does this mean I have an additional $100 I can deduct on other investments, or carry forward to deduct in later years?

[Shojin]

Hmm... so you're saying I may not be able to use that extra $100 of deduction? Or maybe only against other capital gains?

Anyone else out there that does this who can give their input?

[sunnybono]

Ah.. so option b) then.

As a simplified example, if I were to borrow $10,000 at 5% and invest it with a capital gains of 8%, it would be calculated as follows:

8% of 10000 = 800
Taxable portion of capital gains = 800 * 0.5 = 400
Deductable interest on loan = 5% of 10000 = 500

Taxable amount = 400 - 500 = -100. Hence no tax is payable?
Would my net return then be 800 - 500 = $300?

Also, does this mean I have an additional $100 I can deduct on other investments, or carry forward to deduct in later years?

In order to calculate your cost of borrowing you need a timeline. In saying that, lets assume that you borrowed the money for 6 months to get your 8% return/gain (or $800). Then your calculation is as follows

Gain = $800
Cost of borrowing (10000 X5%)/12 months x 6months = $250
Therefore for income tax purposes, your actual gain is $550 of which 50% is taxable at your effective tax rate (or bracket).

Keep in mind if you're borrowing from a Securred Line of Credit that the interest rate is variable and may fluctuate from month to month. thus you're better off getting your exact interest cost from your month Heloc statement.

sk

[Shojin]

Sunnybobo,

Thanks for your input. For simplicity we can assume the period is 1 year.

They way you calculate the taxable amount is different to how kaycee was calculating it. You're in effect using option a). Kaycee is using option b).

So I need to figure out which is correct way to do it.

To be safe, I should assume the worst case senario, which is option a), but it would be nice to know how it actually works.

Anyone else have an opinion on this?

[sunnybono]

Sunnybobo,

Thanks for your input. For simplicity we can assume the period is 1 year.

They way you calculate the taxable amount is different to how kaycee was calculating it. You're in effect using option a). Kaycee is using option b).

So I need to figure out which is correct way to do it.

To be safe, I should assume the worst case senario, which is option a), but it would be nice to know how it actually works.

Anyone else have an opinion on this?

If its one year, then your cost of borrowing is $500, and with you gain at $800, then your net gain is $300. As for capital gain calculation, 1/2 of the $300 is added to your taxes & is taxed based on your bracket!!!

SK

[kaycee8877]

look at a T-1

cap gains line 127

interest expense line 221

calculate the way i said it

sonny is trying to say that interest is only 50 % deductible (which if were the case interest income would only be 50% taxable) which is wrong


and remember that cap gains/losses are only realized when you sell the stock