Realized Versus Unrealized Capital Gains in Non-Registered Accounts

Around tax time, I am often asked why there is a capital gain (or loss) on an account when the investor did not make a withdrawal during the calendar year.  This article will hopefully better educate you on why this can occur. Specifically this covers “non-registered” accounts that hold securities such a stocks, mutual funds or ETFs.  It does not apply to the following accounts.

• RRSPs (RRIFs, LIRAs or LIFs) are not required to report capital gains or losses in the account during the calendar year.  If  a withdrawal  is made by a client, the payment is fully taxable as ordinary income.
• TFSAs are also not required to report capital gains or losses in the account during a calendar year.  When a redemption is made by a client, the payment is not taxable.

If you own a “non-registered” account, it’s important to review your annual statement or contact your financial advisor to ensure you have all the required information before doing your taxes.  For clients with “non-registered” accounts, while they may receive a copy via mail or electronically via email, I typically send the investment company report and a summary review to alert them about this important tax detail.

Please note there is no specific T-slip like the T3 or T5 that you may be familiar in receiving.

Scenario 1: Unrealized Capital Gains (or losses)

Unrealized capital gains (or losses)  are akin to a “paper gain (or loss)”. It’s the increases (or decrease) in the market value of an account when you look at your investment statement.

Below is an example of a 10 security portfolio whereby each security went up 10% during the period, so the portfolio return is 10%.   Therefore even though the portfolio went up $10,000 during the period but no withdrawals were made and no trading occurred in the account.

That’s an “unrealized capital gain” of $10,000 and no tax is reportable.

In the example below, the table shows a 10% loss for each security.  At year end, the portfolio is down $10,000 but again this is a “paper loss” on your statement.  This would be an “unrealized capital loss” and obviously no tax is reportable. 

Scenario 2A: Realized Capital Gain from a Client Withdrawal

In this scenario, let’s assume that the client sold security 1 for $11,000.  As they originally paid $10,000, they have a “capital gain” of $1,000. This is a “realized capital gain” and must be reported when the investor files their income taxes.

Scenario 2B: Realized Capital Gain from Activities

This can occur whether you are trading in your account or have a portfolio manager acting on your behalf.  You aren’t making a withdrawal from the account, you are managing the account based upon changes in the economy and/or investment climate. In this scenario, I’ll assume that the investor does not make any withdrawals during the calendar year but that Security 2 and 3 no longer meets the client’s financial objectives and are sold. Security 2 is sold for $25,000 thereby a “realized capital gain” of $15,000 ($25,000 -$10,000) occurs. Security 3 is sold for $8,000 which is a capital loss of $2000 ($8,000 – $10,000). If these are the only two changes to the portfolio during the year, then the “realized capital gain” is the total of both transactions. A $15,000 gain and $2,000 loss results in a total “realized capital gain” of $13,000 as shown in the table to the right.

This is a “realized capital gain” and must be reported when the investor files their income taxes.

Summary

I hope this article serves as a useful educational tax tip to better understand the difference between “realized capital gains” and “unrealized capital gains” and how it impacts a “non-registered” investment account.