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Beware of Tax Rules – Contributions In-Kind

By Michael Callahan | February 1, 2021

While many investors have good intentions of making TFSA and RRSP contributions, the unfortunate reality is that the cash required to make a meaningful contribution isn’t always available. What can you do?

If you want to make a contribution to your TFSA and RRSP this year, but don’t have the cash available, you can use some of the investments in your non-registered portfolio to make your TFSA and RRSP contributions. The first question is, should you contribute the investments directly, or should you sell them first and then contribute cash? Further, does it matter which investments you choose to contribute, and is there anything else you need to be aware of in this situation?

Let’s take a closer look at the mechanics of making your TFSA and RRSP contributions with investments you already own.

Contributions: In Kind vs. In Cash

The type of transaction described above is known as an in kind contribution. When you make a contribution to your RRSP, TFSA, or other registered account, that contribution can be made in cash, or in kind.

A contribution made in cash is exactly that – cash is contributed to the TFSA or RRSP, and then that cash is used to purchase investments inside the account. However, in some situations, such as the one discussed where cash is simply not available, it is possible to make a contribution to your TFSA or RRSP with existing investments.

For example, let’s assume you want to make a $6,000 contribution to your TFSA. Additionally, let’s assume you also have an Exchange Traded Fund (ETF) in your non-registered account, and the current market value of that ETF is $6,000. If you want to use this existing investment as the source of your RRSP contribution, you now have two options:

  • In Cash: You would first sell the ETF in your non-registered account. In a non-registered account, this is a taxable event. Disregarding any transaction fees for simplicity, you would have $6,000 cash in your non-registered account as the proceeds from selling the ETF, which you can then contribute to your TFSA. Once the money is inside the TFSA, you can then purchase whatever investment you desire.
  • In Kind: For an in kind transfer, you wouldn’t actually sell the ETF at all. Instead, you would just contribute it in kind to your TFSA. So, in this example, if the ETF was worth $6,000 at the time of transfer, this transaction would be treated as a $6,000 TFSA contribution.

Deemed Disposition

In the case of an in kind contribution, even though you didn’t sell the investment first, the CRA treats this transaction as if you did. This is called a deemed disposition, and has associated tax consequences. Most importantly, a deemed disposition can result in unequal tax consequences, as capital gains and capital losses are not treated equally when it comes to in-kind contributions.

  • Scenario 1: In-Kind Contribution with a Capital Gain. If you have a gain on the investment that you wish to contribute in kind to your TFSA, that gain is taxable, and will have to be declared accordingly. So for our example, if the ETF in your non-registered account was purchased for $4,000, and the fair market value is now $6,000, contributing this investment in kind would generate a $2,000 capital gain. Notice, although you didn’t actually sell the investment, the CRA treats this transaction as if you had. Hence, a taxable capital gain is triggered, and any corresponding taxes must be paid.
  • Scenario 2: In-Kind Contribution with a Capital Loss. Conversely, if you have a loss on the investment that you wish to contribute in kind to your TTFSA, that loss will be denied. In our example, if the ETF in your non-registered account was purchased for $8,000, and the fair market value is now $6,000, contributing this investment in kind would generate a $2,000 capital loss. However, although you would incur the loss, the income tax rules in Canada are such that you would lose any associated preferential tax treatment. That is, you cannot claim a capital loss on an in-kind contribution – the capital loss is denied, and cannot be used to offset capital gains generated elsewhere. It’s important to note that this isn’t specific to any investment firm – these are the rules for Canadian investors.

As you can see, this situation involves unequal tax treatment, where capital gains are taxable, but capital losses are denied.

Tax Tip!

As such, you would generally not make an in kind contribution with an investment that is in a loss position. If you want to make an TFSA or RRSP contribution with an investment that has declined in value, it’s generally best to first sell the investment in your non-registered portfolio, and then contribute the cash. Why? By selling the investment first, you will realize a capital loss, and the CRA allows you to use that loss to offset capital gains, either in the same year or future years.

Tax Trap!

However, note that if you re-purchase the same investment inside your registered account within 30 days following the cash contribution, you will fall victim to the superficial loss rule, and CRA will again deny your capital loss.

What, exactly, is the superficial loss rule? Stay tuned for our next blog post to make sure you understand this rule, and more importantly, how to make sure you don’t get caught offside with the CRA.

Bottom Line

Despite the name, the TFSA is an investment account, not a savings account. Further, if you take money out this year, you can’t put it back in until the following calendar year.

For both RRSPs and TFSAs, remember that you have to be responsible for your own contribution amounts, not CRA, because the penalties for over-contribution are quite substantial. The best place to find your contribution limit is your CRA MyAccount or latest Notice of Assessment. Keep in mind that your optimal contribution amount may not necessarily be your contribution limit.

If you have any questions about your investment portfolio or your financial plan, or would like to have a discussion with a Portfolio Manager or Certified Financial Planner, just contact us.

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Michael Callahan