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End the tax year right with strategies to maximize deductions

We're quickly coming to the end of 2005. And people can get pretty creative with their spending to create last-minute deductions. (Hey, sometimes deductions seem so logical you'd swear they must be legal.)

I had a guy approach me at the airport last week. He wanted to know if he could deduct the cost of his dog food. His reasoning was that he runs a business out of his home, with lots of valuable inventory, and his dog acts as a security guard. Therefore, the dog food should be a security expense. I kind of liked that one. I doubt the Canada Revenue Agency would like it as much.

Rather than stocking up on dog food before year-end, why not consider a few of the following capital gain and loss strategies to save tax for 2005?

Defer capital gains where appropriate.

If you're thinking of selling an asset for a profit and the transaction is going to give rise to a tax liability, consider delaying that transaction until the new year to defer the tax until 2006.

Trigger capital gains where appropriate.

It can make sense to trigger a capital gain before year-end if the capital gain won't result in a tax bill. If, for example, you have capital losses to use up, or where the capital gain will be taxed in the hands of someone with little or no other income (in-trust accounts for kids come to mind), then triggering the gain and reinvesting the proceeds will allow you to have a new adjusted cost base in the investment without triggering a significant tax liability.

Claim a capital gains reserve. If you're thinking of selling an asset by year-end at a profit, consider structuring the sale so that you collect your sale proceeds over more than one year. You're able to spread the capital gains tax liability over a period as long as five years if you take payment over five years. At a minimum, consider taking payment partly this year, and partly in January, 2006, in order to spread the tax hit over two years. Consult a tax professional to structure this properly.

Donate securities to charity.

Making a donation by year-end will provide you with a donation credit, and tax savings, for 2005. If you're considering disposing of certain publicly traded securities anyway, think about donating those securities to charity. Any resulting capital gain on the donated securities will be subject to an inclusion rate of just 25 per cent (a half of the usual 50-per-cent rate).

Give investments to a child.

Consider transferring investments to a child before year-end where that investment has dropped in value. This will trigger a capital loss that you can use to offset capital gains, and will pass the tax liability on any future growth in the investment to your child. You'll also minimize probate fees on those investments at the time of death with this idea.

Trigger accrued losses before year-end.

If you have realized capital gains this year, or in one of the three prior years (2002, 2003 or 2004), consider selling any investments that have dropped in value in order to apply the capital loss against those capital gains. Capital losses must be used to offset gains in the current year first, but excess losses can then be carried back up to three years or forward indefinitely.

Close out option contracts with losses.

If you close out option contracts with accrued capital losses before year-end, you'll be able to utilize those losses to offset realized capital gains this year, or in 2002, 2003 or 2004.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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