Calculating adjusted cost base: A case study

If you’ve read our ironically titled white paper, As Easy as ACB, you understand how complex it can be to track the adjusted cost base of ETFs. You need to account for all purchases and sales of shares during your holding period and then adjust for any reinvested distributions, return of capital and share splits along the way. Since that paper came out, several readers have emailed to ask whether it’s really necessary to do all that work.

That’s up to each investor to determine, but I wouldn’t want the Canadian Revenue Agency to discover you were paying a lot less tax than you owed. And as we discovered recently with a client of our DIY Investor Service, taking the time to accurately calculate your adjusted cost base can also save you from paying unnecessary taxes.

Our client purchased 300 shares of the iShares S&P/TSX Composite Index ETF (XIC) in September 2005 and added another 200 shares the following year. She eventually sold the entire holding (which by then had more than doubled in value) in April of this year. On the surface that seems like a straightforward set of transactions, but along the way the following events took place:

• XIC had a four 4:1 stock split in 2008, which turned the client’s 500 shares into 2,000
• five reinvested capital gains distributions (including three large ones in 2005, 2006 and 2007)
• 33 return of capital distributions

Remember that dividends paid in cash do not affect the adjusted cost base of an ETF. However, had the client elected to use a dividend reinvestment plan (DRIP) we would have had to account for a few dozen additional transactions. Fortunately she did not.

Nervous breakdown

We started by collecting the tax breakdown information from the CDS Innovations website: we needed to retrieve the spreadsheets for XIC from 2005 through 2013. Then we entered all of this information into AdjustedCostBase.ca using the techniques described in our white paper. After accounting for all 42 items, the site allowed us to save a summary in Excel (I’ve added some formatting and deleted unnecessary columns to make it easier to read).

What was the result of this exercise? Each of the reinvested capital gains distributions allowed our client to increase her adjusted cost base, and over the years that added more than $2,900 to the final book value. The return of capital distributions, meanwhile, lowered her ACB by about $538. So the net result was the ACB on the holding was almost $2,400 more than it would have been if she had simply calculated it using the purchase and sale prices. Based on her marginal tax rate of 21.7% on capital gains, this should result in a tax savings of more than $500.

Bottom line, calculating your adjusted cost base is not necessarily easy, but taking the time to do it properly could save you a significant amount of money when you ultimately sell your shares.