# Convert interest income to capital gains



## james4beach (Nov 15, 2012)

With bonds falling so dramatically, I'm happy to see that discount bonds are back in play -- we're getting more Canadian bonds trading below par. This makes it possible to do some fixed income investment that is capital gains focused, effectively converting interest income into capital gains.

That would be ideal for someone who for example has accumulated capital loss carry forwards and the ability to nullify any capital gains.

For example, let's say you currently have cash sitting in a savings account earning 1% and you're paying high tax on the interest income. You could alternatively buy Government of Canada March 2022, 0.5% coupon, 1.16% yield at 96.627 per 100 par.

Say you did this with 100K face. In five years, this produces a guaranteed capital gain of $3,373 and minimal taxable interest income along the way. I think there are even lower coupon bonds out there that are farther below 100.

Another way to do this is to buy ZDB, discount bonds ETF which minimizes taxable interest income. Should be very good for non-registered.


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## james4beach (Nov 15, 2012)

By the way, I almost exclusively hold low coupon bonds in my own bond portfolio to minimize taxable interest income (boosts capital gains, minimizes interest income). Here's a thread to track my performance:

Running my own bond fund, comparing to VAB


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## agent99 (Sep 11, 2013)

If like many, you have held equity in your taxable account for some time and have substantial paper capital gains, you, like me, might be hesitant to sell. 

Using your suggestion to buy bonds in taxable account, why not buy Premium bonds and accumulate capital losses when they mature. Then when need be, sell some equity that has gained without incurring a net CG?

I keep all our bonds in registered accounts, so have not done this.

By the way, you can only carry forward losses for 3 years so wouldn't bonds have to be very short term for your idea to work?


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## james4beach (Nov 15, 2012)

The capital loss can be carried forward indefinitely. You're thinking of carrying back, which is only 3 years
http://www.taxtips.ca/filing/capitallosses.htm

But sure, you could use premium bonds as a way to induce large capital losses, but then you're going to get stuck with large coupons that will incur high tax liability. So you'll get the cap loss, but (even worse) high interest income.

By the way I would put my bonds in a registered account if I could, but US/Canada tax complications have left me with very limited registered room.


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## agent99 (Sep 11, 2013)

james4beach said:


> The capital loss can be carried forward indefinitely. You're thinking of carrying back, which is only 3 years
> http://www.taxtips.ca/filing/capitallosses.htm


You are right - I was thinking about carrying back.



james4beach said:


> But sure, you could use premium bonds as a way to induce large capital losses, but then you're going to get stuck with large coupons that will incur high tax liability. So you'll get the cap loss, but (even worse) high interest income.


If you invest in bonds, receiving high interest would be a good thing, no? Nothing wrong with paying more tax if you earn higher returns


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## james4beach (Nov 15, 2012)

Instead of "high interest income" I should have said "high coupon income". The coupons are the part you don't want, because those are categorized as taxable interest income by CRA and taxed as highly as regular income.

Say you can do this two ways on the extremes
A: discount bonds with small coupons
B: premium bonds with large coupons

And let's say that both A and B have the same yield to maturity, the same rate of return. That is, if tax effects were ignored you get the same total return.

If you use A, then the coupons are small and so your "taxable interest income" is minimal. You end up with a cap gain.
If you use B, then coupons are large and your "taxable interest income" is high. You end up with a cap loss.

I can't see why B would be preferable in a taxable account. Even if the capital loss is desirable, you're still stuck with the big coupons and pay a high tax on them. I'm not sure that the usefulness of a capital loss can outweigh that.


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## AnonymouslyInvesting (Nov 29, 2016)

Very true James. What matters is yield to maturity and price for taxable accounts. Still somewhat tough to find inventory on decently yielding investment grade bonds. GICs are pretty attractive in the short end (1-2 years) for their yield and safety through CDIC coverage.


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## like_to_retire (Oct 9, 2016)

james4beach said:


> For example, let's say you currently have cash sitting in a savings account earning 1% and you're paying high tax on the interest income. You could alternatively buy Government of Canada March 2022, 0.5% coupon, 1.16% yield at 96.627 per 100 par.


Even with tax consideration, I doubt it would overcome a GIC at 2.5% (CTC 5 Year rate). The bond would certainly offer you liquidity, but if that isn't a big concern, why would you go this route.

ltr


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## humble_pie (Jun 7, 2009)

james4beach said:


> For example, let's say you currently have cash sitting in a savings account earning 1% and you're paying high tax on the interest income. You could alternatively buy Government of Canada March 2022, 0.5% coupon, 1.16% yield at 96.627 per 100 par.
> 
> Say you did this with 100K face. In five years, this produces a guaranteed capital gain of $3,373 and minimal taxable interest along the way.




i'm fairly sure that most folks on here with 100k or more sitting in cash already have those funds out in HISA at 2%. What's more, these folks want _*available cash*_, not a bond that's tied up until maturity 5.25 years from now (notice it's 5.25 years, not 5 years.)

when we get down to the nitty-gritty, all we would receive aross 5.25 years, according to your rule, is a sneeze of $3,373 in capital gains plus a few dollars in interest income?

that is $643 income per annum, none of it payable until march 2022. 

a person could make much better money babysitting.

or maybe go sell a few options.


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