“My fund has dropped in value and I have received a T3 tax slip - why do I have to report fund distributions on my income tax return if I’ve lost money this year?”
From the client’s viewpoint, he believes that the T3 just adds insult to injury. Why would he have to pay tax on something that has dropped in value?
This question is quite common and sometimes the best explanation is the simplest.
In client presentations I have often used our homes and houses as examples to help explain how mutual funds work.
I’ve changed it a bit to make it specific to the client’s taxation question:
“You’ve bought a second house in town as an investment. Naturally, you’ll want to rent it out to cover your unavoidable costs (MER?) that you will incur – things like property taxes, upkeep, repairs, etc. Unfortunately, the real estate market has temporarily gone down in value and the property is worth less than what you bought it for. Although you know that you’ve lost money on your purchase (on paper), you still have to declare the rental income on your tax return whether or not the house has gone up or down in value.”
This same sort of rule applies to mutual funds that generate investment income throughout the year. Some mutual funds can consist of dozens of individual stocks, some of which pay dividends throughout the year. Dividends along with any interest income and capital gains are all taxable items.
If however, you have a mutual fund in a RRSP or RRIF, everything is tax sheltered and mutual fund distributions are neither reported nor taxed.