Canadian Money Forum banner

1 - 12 of 12 Posts

·
Banned
Joined
·
1 Posts
Discussion Starter #1
HI

I started my margin account a while ago and got fortunate enough to get a good prime+0.5 interest rate. Wich scurrently stand at 3.5%.

I used the margin and bought a lot of rei.un and my average cost is only $15 as of now.
Now, rei.un is at $22.90 and the yeild is now only 6.1%

Since this holding is in a margin account, it's not tax efficient and I pay full tax on dividend received. Living in alberta, my tax bracket is 32% for 'other income' . My interest paid for income providing investment (my margin fee) is tax deductible at 32% again.

Was doing some math and wonder if it's right:

I could buy $10000 of rei.un-t on margin right now
yield is 6.1%-3.5% (my margin fee)= 2.6% profit on investment
remove the tax and it leave me with only 1.76% profit on my margin account.
That may not justify the use of more margin when interest rates are likely to keep going up in a medium term melting that 1.76% like snow under the sun.

My other option was to buy a prefered share like pow.a-t
at $24.50, it yield a 5.7% dividend but is 'eligible dividend'.
Tax on that distribution is only about 6%. after tax it's 5.24% yield
So It leave me with (5.7x.92)-(3.5x.68)=2.86% profit on the margin account

without using too much leverage on the margin and becoming risky, getting 2.86% return on money I do not own is pretty tempting.


If you were me, would you keep DRID the dividend of rei.un as I'm currently doing or use the money and buy some solid prefered shares instead.



thanks
 

·
Registered
Joined
·
26 Posts
Very tempting, but watch out for the interest rate risk. You are borrowing short term in your margin account and lending long by buying a perpetual prefered like POW.PR.A.

If interest rates go up, as they will at some point in time, your interest cost will go up, but your dividends will not. At that time the prefered will sell at a lower price, so you may incur a loss to close the position. POW.PR.A traded in the 21.5 area in May.
 

·
Banned
Joined
·
967 Posts
I'm not that familiar with tax laws in Alberta, but only a portion of the distributions ought to be 100% taxable. The rest are either eligible dividend and/or return of capital. In Ontario, and my taxable bracket, I much prefer ROI, then capital gain, then eligible dividend, and lastly interest.

The tax rate is about the same for ROI, capital gain, and eligible dividend, but ROI, you get the cash upfront, but gets to defer the tax. Capital gain is good with the deferred tax, but you're "stuck" with that particular investment.
 

·
Registered
Joined
·
10,621 Posts
I'm not that familiar with tax laws in Alberta, but only a portion of the distributions ought to be 100% taxable. The rest are either eligible dividend and/or return of capital. In Ontario, and my taxable bracket, I much prefer ROI, then capital gain, then eligible dividend, and lastly interest.

The tax rate is about the same for ROI, capital gain, and eligible dividend, but ROI, you get the cash upfront, but gets to defer the tax. Capital gain is good with the deferred tax, but you're "stuck" with that particular investment.
Hmmm ... where you say "ROI", don't you mean ROC or Return Of Capital?

In which case, it's really a capital gain as the ROC part is reducing your cost so that when you sell, more will be a capital gain.


I'm also thinking the "tax rate is the same for ROC, capital gain and eligible dividend" is misleading. Once your tax bracket is set and all of the adjustments are made, the rate is the same - what puts you there makes all of the difference.

A few years ago, I plugged in $50K in capital gains, dividends and income. The resulting tax bills were approximately $6K versus $8K versus $14K, after the personal exemption was deducted.

The bottom line is that you keep more of the capital gain.


Also - if you don't like the investment - why did you buy it?
Or did you mean something different when you said "stuck"?

Cheers
 

·
Registered
Joined
·
240 Posts
If you're using leverage , and increasing risk anyway , I would add a "little" more risk and up the income , such as buying a smaller cap REIT that pays better , say BTB.UN at allmost 12%.

12% - 3.5% = 8.5% , worth the risk in my opinion.

Or even TR.UN at 17% - 3.5% = 13.5% , higher risk , but good return.

Just a thought.
 

·
Banned
Joined
·
967 Posts
Yes, I meant ROC. ROC is better than capital gain, because ROC is a cash distribution that you can use to purchase a different investment if you wish (flexibility). You could even spend that ROC distribution without immediate tax consequences. Whereas capital growth cannot be spent on purchases until you sell, at which time you will realize taxes.

So ROC is better than capital gain.
 

·
Registered
Joined
·
3,423 Posts
Don't forget that if you receive ROC payment from a leveraged investment - you have to keep that payment portion inside the investment account or reduce the amount of interest that you are claiming or use the ROC to pay down the investment loan.

Removing ROC from the investment account is the same as making a withdrawal.
 

·
Registered
Joined
·
10,621 Posts
Yes, I meant ROC. ROC is better than capital gain, because ROC is a cash distribution that you can use to purchase a different investment if you wish (flexibility). You could even spend that ROC distribution without immediate tax consequences. Whereas capital growth cannot be spent on purchases until you sell, at which time you will realize taxes.

So ROC is better than capital gain.
Thanks for clearing up the ROI and ROC.

I guess part of my confusion is the reference to taxes. ROC and Capital Gains have the same tax consequences but as you correctly point out, the ROC distributions can be spent, including possibly re-investing in something, without tax consequences, until the sale of the investment. Though as I'm painfully experiencing, it's a good idea to get the bookkeeping out of the way on at least a quarterly basis. I've had trustunits bought out, the web site shutdown and then it's a pain to figure out the ROC amounts.
 

·
Registered
Joined
·
10,621 Posts
Don't forget that if you receive ROC payment from a leveraged investment - you have to keep that payment portion inside the investment account or reduce the amount of interest that you are claiming or use the ROC to pay down the investment loan.

Removing ROC from the investment account is the same as making a withdrawal.
Okay ... I'm confused.

To write off investment interest, the qualified investment must be in a taxable account. So what bearing does "keep the payment inside the account" have?

As soon as you were paid the ROC, it's already withdrawn. This means your only two options are to use bookkeeping to claim the correct interest or pay down the investment loan so that the lender does the bookkeeping for you.
 

·
Registered
Joined
·
10,621 Posts
Yes, I meant ROC. ROC is better than capital gain, because ROC is a cash distribution that you can use to purchase a different investment if you wish (flexibility). You could even spend that ROC distribution without immediate tax consequences. Whereas capital growth cannot be spent on purchases until you sell, at which time you will realize taxes.

So ROC is better than capital gain.
Hmmm ... actually ROC is your original capital coming back to you.

The other factor is to that the ROC has to be deducted from the Adjusted Cost Base (ACB). I'm not sure how long it would take but if the ACB hits zero or negative, then two things happen:

a) all future ROC payments have to be declared as capital gains on the
appropriate tax returns. For example, if the ACB hits zero in Nov 2010,
the Dec 2010 ROC is reported on the 2010 return and if nothing is done,
*all* of 2011 ROC payments are reported on the 2011 return.

b) when the trust units are sold, if the ACB is zero or less, all of the proceeds
are reported as a capital gain (i.e. no cost).
 

·
Banned
Joined
·
94 Posts
HI

I started my margin account a while ago and got fortunate enough to get a good prime+0.5 interest rate. Wich scurrently stand at 3.5%.

I used the margin and bought a lot of rei.un and my average cost is only $15 as of now.
Now, rei.un is at $22.90 and the yeild is now only 6.1%

Since this holding is in a margin account, it's not tax efficient and I pay full tax on dividend received. Living in alberta, my tax bracket is 32% for 'other income' . My interest paid for income providing investment (my margin fee) is tax deductible at 32% again.

Was doing some math and wonder if it's right:

I could buy $10000 of rei.un-t on margin right now
yield is 6.1%-3.5% (my margin fee)= 2.6% profit on investment
remove the tax and it leave me with only 1.76% profit on my margin account.
That may not justify the use of more margin when interest rates are likely to keep going up in a medium term melting that 1.76% like snow under the sun.

My other option was to buy a prefered share like pow.a-t
at $24.50, it yield a 5.7% dividend but is 'eligible dividend'.
Tax on that distribution is only about 6%. after tax it's 5.24% yield
So It leave me with (5.7x.92)-(3.5x.68)=2.86% profit on the margin account

without using too much leverage on the margin and becoming risky, getting 2.86% return on money I do not own is pretty tempting.


If you were me, would you keep DRID the dividend of rei.un as I'm currently doing or use the money and buy some solid prefered shares instead.



thanks
This is a very dangerous strategy. Once the interest rate goes up you will lose both on paying more interest rate and reduction of value in the equity you bought, as they will be interest rate sensitive.
 
1 - 12 of 12 Posts
Top