How Return OF Capital Works
The topic of Return OF Capital has been discussed at nauseum in the comments, but I thought that I should bring it to the front page as the same questions keep coming up.
What is ROC?
Return of Capital is when a publicly traded company distributes money collected from their share holders back to the share holders themselves. The resultant distribution is non taxable but decreases the adjusted cost base of the original purchase (tax deferral). When it comes time to sell in the future, providing that there is a profit, the capital gains tax will be paid on the new adjusted cost base minus the selling price.
Purchase XYZ income trust for $10, it distributes an annual ROC of $1. Sell 1 year later for $20. The capital gain is: $20 – ($10-1) = $11
Who distributes ROC?
Income trusts and some corporate mutual funds. The biggest indicator of ROC is if the distribution is extremely high relative to the yields of the strong dividend stocks.
What about ROC and Leveraged Investing?
For leveraged investing, it is not preferred to buy anything that has a return of capital component in their distribution as ROC reduces the tax deductibility of the investment as it is received.
One way around this is to use the ROC distribution to pay down the investment loan and re-invest if desired. Technically though, this should be the same as leaving the ROC distribution within the investment account. However, this assumption needs to be confirmed with CRA or an accountant.
Receiving ROC in a leveraged investment account can also be an accounting nightmare if dividends/interest/ROC are mixed together in a distribution, and regular withdrawals from the leveraged account are needed (like with my version of the Smith Manoeuvre).
Please see the article “Key Considerations of an Investment Loan” for more details.
I would be grateful if tax experts/accountants would chime in!
Disclaimer: Information provided in this article are for entertainment purposes only and if used, it is at your own risk. Please consult a tax expert before implementing anything you read here