Investor Questions – Capital Gains Versus Income

I often get asked questions regarding matters that are in the realm of an accountant. One of the most asked questions is about capital gains versus income. I thought I would write this up in the investor questions section so that others can reference it in the future,

Investor Question on Capital Gains Versus Income

“Hi Teddi, I believe you trade from Canada ? If yes I was wondering if you can give me your opinion on capital gain VS income. I heard a few people telling me that almost anyone that is successful at stock trading can have his profits labeled as income instead of capital gain. From the frequency of the trades, options used or the time spent analyzing the market, the criteria looks ridiculous to me but the fiscal consequences are huge as it make your taxable income jump from 50 % to 100 %. Since you are a successful investor and trader who generate high profit and probably a lot of trading activities, what is your take on this situation?  Any advice or personal experiences on the subject would be greatly appreciated.”

My Answer

I am not an accountant so my answers are from what I understand or perhaps a better phrasing would be “from what I think I understand”. I have been investing a long time. To my knowledge in Canada we have a lifetime limit on capital gains. I found this on the Canadian Revenue Agency Website.

“Currently, on the disposition of qualified property, an individual may be eligible for a capital gains deduction of up to $375,000, which is ½ of the $750,000 lifetime capital gains exemption (LCGE). These properties are qualified small business corporation shares, and qualified farm and qualified fishing property.

For the 2014 and subsequent tax years, the budget proposes to increase the LCGE from $750,000 to $800,000. The budget also proposes to index the LCGE after 2014 for inflation.  The new LCGE limit will apply for all individuals, even those who have previously used the LCGE. The CRA is committed to providing taxpayers with up-to-date information. The CRA encourages taxpayers to check its Web site often. All new forms, policies, and guidelines will be posted as they become available.”

My Capital Gains Are Long Gone

My own personal capital gains exemption is long gone having used it up years ago. With the increase from this year it looks like I may get an additional $50,000 in exemptions. The problem is how the trades are deemed by the CRA. There are a number of rules for how stock trading is looked at and I am no expert on those. My understand is that if you trade often in the same stock, which is something I do, then it is deemed as income. Don’t take my word of that, but talk to an accountant. I also know you can set up a company to handle your trading and I would think that would save on taxes.

Retirement Accounts and Tax-Free Savings Accounts Are Not Taxable

As you are probably aware in Canada (and the USA) retirement accounts are not taxed until the income is removed. I won’t get into all the removal obligations but suffice to say by the time you are my age you are “forced” to remove a percentage from your retirement nest egg every year and pay tax on that amount.

In Canada we also have tax-free savings accounts and education savings plans that are not taxed. The tax-free savings account is interesting in that even when the capital is taken out it is not taxed. But then we have a lot of restrictions on what we can and cannot trade in these “savings type tax-free accounts”. Basically we can sell covered calls or buy options but we cannot sell to open options for income or profit. Even cash secured Put Selling is not allowed. Who knows maybe someday that will change.

Canadian Members Site

This is also a big part of why I am finishing up the Canadian Members site. We live in a different environment for stocks than the USA markets. Options in Canada are also quite different for trading. All the options I trade are handled out of Montreal and honestly they have some pretty weird pricing at times. I have seen spreads of bid and ask on options as wide as 50 cents. I have also had fills and then had them rejected hours later when the stock moved in my favor. It’s a weird and strange world dealing with Canadian options and they need a different way of being handled. I am looking forward to delving into stocks on my home turf.

My Take On Taxes

Personally I pay a whack of tax but then I also enjoy this great country. I just wish Governments spent money more wisely but then it was Winston Churchill who said back in 1947, “Many forms of Government have been tried, and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all-wise. Indeed, it has been said that democracy is the worst form of government except all those other forms that have been tried from time to time.”

I look at my trading that even if I earned 12% or 60% I am still paying a lot of taxes. I aim for the return and let my accountant worry about the taxes. My accountant also handles audits from Revenue Canada on my behalf and answers all questions. I consider that a big plus.

My personal opinion is I would aim for the $800,000 capital gains exemption and maybe set up accounts for immediate family members as well. Then set up trading authority for yourself. Realize though that the account is not in your own name and I am no lawyer, but I would think the money then belongs to the account holder.

In Summary

These are the types of questions to ask an accountant and lawyer although I would think an accountant would have all the answers. I kind of like the idea of a company though especially if trading full-time. It would be interesting to know what the tax laws are for that type of company or whether it is even feasible. I wonder if I could write off travel trips to various conventions and a much bigger monitor? Now wouldn’t that be nice!

Thanks for your question. I hope my answer has been of some help. Remember that everything you read is just my opinion based on my very limited knowledge so make sure you check with someone far more knowledgeable than I. Personally I think everyone who trades for themselves with more than $100,000 should have an accountant.

If you have an opinion or some knowledge on this topic please share it with others below. Select to read more investor questions.

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