Tax efficiency 101: Key strategies to help build your wealth

Understanding taxation is a crucial part of investment planning. After all, how your investments are taxed directly affects how your wealth grows over time. That’s why investing with tax efficiency in mind—paying the minimum tax required by law—is a key strategy for savvy investors.

Investing without understanding taxation is like trying to heat a house with the windows open. Yes, some heat will escape no matter what (just like some taxation is unavoidable), but if you close the windows, you’ll reach your goal a lot more efficiently. Ready to close some windows? You came to the right place.

How investments are taxed in Canada

Canada has a progressive tax system, meaning your tax rate increases with your income. Additionally, different types of investment income are taxed at different rates, regardless of income. By understanding the types of investment income and how they’re taxed, you can make investment decisions that better align with your goals while reducing your tax burden.

The most common types of investment income in Canada are:

Capital gains

• When you sell an investment at a higher value than you paid for it, the profit you incur is a capital gain. Only 50% of your capital gains is added to your income and taxed at your marginal tax rate.
• It is important to note that some aspects of the capital gains inclusion rate will change effective January 1, 2026. For individuals, the inclusion rate will remain at 50% up to a $250,000 amount, and for any additional amount, it will increase to 66.67%. For corporations and most trusts, the inclusion rate will increase to 66.67% for any amount.
• Capital gains are widely regarded as the most tax-efficient investment income type in Canada.
• Investments that can generate capital gains income include real estate (including real estate investment trusts, or REITs), stocks, bonds, and mutual funds.

Dividends

• Dividends are paid by many publicly traded companies.
• They are taxed at a lower rate than interest income, making them a more tax-efficient option.
• In Canada, the tax rate for dividends differs depending on whether the dividend is eligible or non-eligible. Eligible dividends typically come from Canadian public companies and non-eligible dividends typically come from smaller or private companies. Both types qualify for a dividend tax credit, but the credit is higher for eligible dividends.

Interest

• Interest income is taxed at the highest rate compared to other income types.
• It is subject to your marginal tax rate, meaning there are no special tax breaks.
• Investments that generate interest income are typically considered more conservative options. These include savings accounts, bonds, and GICs.

3 considerations for tax-efficient investing in Canada

1. Investing through tax-advantaged accounts

One of the most popular and effective ways to reduce your tax burden is to invest through tax-advantaged accounts, also referred to as registered accounts. Many investments, like real estate investment trusts (REITs), stocks, bonds, and mutual funds, are eligible for registered accounts. Ineligible investments include personal assets (like collectibles), precious metals, and land.

Tax-advantaged accounts offer various tax benefits to help build your wealth more efficiently. They include:

• Registered Retirement Savings Plan (RRSP)—helps you save for retirement. Contributions to an RRSP are tax-deductible and investments are tax-sheltered until withdrawal.
• Tax-Free Savings Account (TFSA)—allows your investments to grow tax-free. Withdrawals are not subject to tax, making TFSAs a flexible savings tool.
• Registered Education Savings Plan (RESP)—helps you save for a child’s post-secondary education, with tax-deferred investment growth and special government grants.
• First Home Savings Account (FHSA)—helps you save for a down payment for your first home with tax-deductible contributions and tax-free withdrawals for a home purchase.

Each tax-advantaged account has specific tax rules, and any investments in them—no matter the investment type—are subject to those rules. Each of Skyline’s private alternative investments is RRSP, TFSA, RESP, and FHSA eligible.

2. Asset allocation

Asset allocation means investing your money in a variety of investment products to achieve a diverse mix in your portfolio. Many investors diversify their portfolios by owning a variety of non-correlated investments, with the goal of protecting the overall portfolio from volatility. For example, you might choose to own a mix of public and private investments. Private investments are valued differently than their public counterparts and are less correlated with potential public market volatility.

Further, you might also choose to diversify by owning investments with different tax treatments. Strategically allocating those investments in the right types of accounts can significantly decrease your tax burden.

For example, you may decide to maximize your RRSP with investments in interest or dividend-earning funds, but hold capital gains-earning investments, which already have built-in tax advantages, in non-registered accounts.

3. Cash flow

Your cash flow needs also play a key role in shaping a tax-efficient investment strategy. If you require regular income from your investments, you may want to consider options that provide tax-efficient distributions, especially in the form of return of capital (ROC), which is the repayment of your original investment and does not trigger taxation. REITs (like Skyline’s REIT investments), mutual funds, and ETFs are examples of investments that may provide return of capital distributions.

If you don’t need regular cash flow, you may want to choose an investment that offers a distribution re-investment plan (DRIP). This plan automatically reinvests your earnings, allowing your money to compound over time while deferring taxes. Each of Skyline’s funds also offers a DRIP option.

Beyond tax-advantaged accounts, asset allocation, and cash flow planning, there are several other ways to enhance tax efficiency when investing, including:

• Investing through a holding company, which can provide tax deferral opportunities.
• Tax-loss selling, which can offset capital gains and reduce taxable income.
• Income splitting, where investment ownership is shared with a lower-income spouse or family members to reduce the overall tax burden.
• Charitable donations, which can provide tax credits while avoiding capital gains tax.

Unlocking the potential of private alternative investments: REITs

Alternative investment products, like real estate investment trusts (REITs), offer potential investor advantages when compared to other investment types, thanks to unique taxation rules.

Canadian REITs must pay out at least 90% of their taxable income to investors. In return, REITs are exempt from paying most, if any, corporate income tax. This means your distribution comprises the REIT’s pre-tax income, instead of after-tax dividends—often resulting in a more attractive return. With this structure, REITs avoid the double taxation (corporate tax and personal income tax) that other dividend-paying investments may be subject to.

A key advantage of REITs is that a portion of their distributions are classified as return of capital, which is not considered a taxable event since you’re receiving a repayment of your original investment.

When you receive distributions as return of capital, it reduces your adjusted cost base (ACB), which is the amount you originally invested. As you continue to hold the investment and receive distributions, your adjusted cost base will continue to erode, potentially to zero.

When you choose to redeem your investment, your adjusted cost base at that time determines the amount you’ll be taxed in capital gains. Only 50% of your capital gain is added to your income and taxed at your marginal tax rate (as mentioned previously, some aspects of this inclusion rate will be changing effective January 1, 2026). Compare this to traditional real estate ownership, where your rental income is fully taxed as regular income, and you can see why investors may want to consider including REITs in their financial strategy.

Promoting tax efficiency with Skyline’s private alternative investments

Skyline Wealth Management offers a range of private alternative investments for Canadian investors, including REITs, that provide potential tax efficiency, as well as the opportunity to use a DRIP to re-invest your earnings. These investments not only help mitigate tax exposure, but they also have a track record of resilience amid market uncertainty. Skyline’s funds have a historical annualized return of 9-15% as at December 31, 2024.

Building a tax-efficient investment portfolio can help you save money at tax time, so you can grow your wealth faster.

The contents of this article are not meant to replace advice from your accountant or any other tax advisor. We strongly suggest that you consult with your accountant or tax professional prior to investing and on an ongoing basis.