Investing is rewarding and, at times, exciting — but too often, investors lose more than they should due to taxes. The good news? With the right knowledge, you can legally and strategically minimize how much the CRA takes and maximize how much stays compounding in your portfolio.
This guide pulls together everything Canadians need to know about dividends, ETFs, REITs, capital gains, distributions, and account types — all explained clearly and backed with real-world examples so you can keep more of what you earn.
Key Concepts & Definitions
Before we deep dive into the investor tax world, let's align on commonly used terms.
Marginal tax rate — the rate you pay on your next dollar of ordinary income. Important because many investment incomes are taxed as if they were ordinary income (or close to it).
Dividends (Canadian) — paid by Canadian corporations. Because corporations already paid tax, there is a system of gross‑up + dividend tax credit to avoid double taxation. Eligible vs non‑eligible dividends matter (eligible dividends benefit from better gross‑up / credit amounts).
Interest / Other Income — fully taxed at your marginal rate. No special credits.
Capital gains / losses — only 50% of capital gains are included in your income (“inclusion rate”). Capital losses can offset capital gains. Superficial loss rules apply.
Distributions vs Dividends — especially important for REITs, income trusts, mutual funds. Distributions may include: rental/operating income, capital gains, return of capital (ROC), foreign non‑business income. ROC reduces the adjusted cost base (ACB).
Accounts matter — whether you hold investments in a non‑registered (taxable) account vs TFSA, RRSP/RRIF, or RESP has huge impact on when and how taxes are paid.
💡 Did You Know?
At some income levels, Canadian eligible dividends can actually have a negative effective tax rate thanks to the dividend tax credit. That means you may pay less tax overall by holding Canadian dividend stocks in a taxable account than by earning the same income from interest.
Other Important Rules & Planning Strategies
Gross‑up & Dividend Tax Credit — for eligible Canadian dividends. Helps reduce the effective tax burden vs interest.
Foreign withholding taxes — e.g. U.S. dividends (generally 15% withheld, unless held in certain account types).
Currency gains / losses — when buying or selling foreign‑denominated securities, or converting proceeds. Must convert to CAD for tax reporting.
Superficial Loss Rules — you cannot claim capital losses if you repurchase “identical property” within 30 days (before or after) of disposition.
ACB tracking — when you buy in multiple lots, DRIPs, reinvestments, ROC, etc. Mistakes here lead to under‑reporting of gains (or overpaying tax).
Timing and account choice — e.g. holding high‑yield / high‑tax income assets in TFSA or RRSP to shelter, and holding lower‑taxed dividend or growth assets in taxable accounts if needed.
💡 Did You Know?
You can control when to realize capital gains. If you sell in a year when your income is lower, you may pay far less tax on the same gain.
Understanding Canadian Investment Taxes
Every dollar you pay in unnecessary taxes is a dollar that can’t grow for you. Your marginal tax rate—the rate you pay on the next dollar of income—determines how much you keep from your investments. Some income types get special breaks, while others are fully taxed. Understanding these differences is key to building an efficient portfolio.The Big 5 Income Types
Canadian Eligible Dividends: Favoured by the tax system through the gross‑up and dividend tax creditmechanism. Great for taxable accounts.
Non‑Eligible Dividends: Receive a smaller credit and are taxed closer to regular income.
Capital Gains: Only half of the gain is taxable, and you control when to realize it.
Interest Income: Fully taxed at your marginal rate.
REIT & Trust Distributions: Can include ordinary income, capital gains, and return of capital (ROC). ROC is not taxed immediately but reduces your Adjusted Cost Base (ACB).
Don’t Forget Foreign Income
Dividends from U.S. or international companies are taxed as ordinary income in Canada, with no dividend tax credit. In taxable accounts, foreign withholding tax (often 15% for U.S. stocks) applies — though you can claim a credit. In RRSPs, U.S. dividends are generally exempt from withholding tax under the treaty.
💡 Did You Know?
Holding U.S. dividend stocks in an RRSP means you usually avoid the 15% U.S. withholding tax. In a TFSA, however, that tax is lost forever.
Choosing the Right Account
Where you hold an investment is just as important as what you hold. Use this quick reference chart to see how each type of income is taxed in a non‑registered account and where it fits best:
Dividends vs Distributions — Key Differences
It’s easy to confuse dividends and distributions, but they are not the same. A dividend is paid by a corporation from after‑tax profits and benefits from the dividend tax credit. A distribution, on the other hand, can include multiple income types and requires more tracking on the accounting side.
📝 Example Comparison:
Dividend (e.g., Bank of Montreal common share):
$1,000 dividend → grossed‑up and eligible for federal/provincial dividend tax credits.
Tax‑efficient in taxable accounts, especially at lower income levels.
Reported on a T5 slip.
Distribution (e.g., RioCan REIT unit):
$1,000 distribution → may be broken down into $400 ordinary income, $300 capital gains, $200 ROC, $100 foreign income.
More complex reporting, ACB adjustments needed for ROC.
Reported on a T3 slip.
This difference matters because investors who assume all distributions are like dividends may overpay or underpay tax if they don’t check their T3 slips.
REITs & ETF Distributions — Special Cases
Distributions from REITs and ETFs can often confuse investors because they are not the same as dividend payments. While dividends are straightforward — paid from after‑tax profits of a corporation and reported on a T5 — distributions can include a mix of income types, each taxed differently and reported on a T3.
Breaking Down Distributions
Return of Capital (ROC): Not taxable in the year you receive it, but it reduces your Adjusted Cost Base (ACB). Over time, this increases your capital gain when you sell. If ROC brings your ACB to zero, further ROC is immediately taxable as capital gains.
Ordinary Income: This can be rental income for REITs or interest‑like income within ETFs. It is fully taxed at your marginal tax rate.
Capital Gains: Sometimes REITs or ETFs distribute realized capital gains from portfolio sales. These are taxed at the 50% inclusion rate.
Foreign Income: Some ETFs holding U.S. or international assets distribute foreign dividends or interest. These are taxed as regular income in Canada and may be subject to foreign withholding taxes.
Options & Covered Call ETFs: An increasingly popular strategy among Canadian ETFs is writing covered calls to generate income. The premiums received are generally taxed as capital gains if the ETF holds securities directly and writes the options for income. However, depending on structure, portions may also be considered business income or distributions of ordinary income. Investors should review the T3 slip breakdown carefully each year to understand the character of this income and the implications for tax planning.
Why This Matters?
If you hold REITs or broad income‑focused ETFs in a taxable account, you must carefully track the breakdown reported on your T3 slip each year. ROC adjustments need to be applied to your ACB to avoid paying extra tax later. In contrast, if you hold these in a TFSA or RRSP, you avoid most of this complexity (though foreign withholding tax can still apply in a TFSA).
📝Example: You receive a $1,000 distribution from a REIT ETF.
$400 is ordinary income → taxed at full marginal rate.
$300 is capital gains → 50% taxable.
$200 is ROC → no immediate tax, but reduces ACB.
$100 is foreign income → taxed as ordinary income; possible withholding tax.
In a taxable account, you would pay tax now on $400 + $150 + $100 = $650. The $200 ROC is deferred but will increase future gains when you sell.
💡 Did You Know?
Return of Capital (ROC) isn’t free money. Each ROC distribution lowers your Adjusted Cost Base (ACB). Once your ACB hits zero, any additional ROC is immediately taxable as a capital gain.
Complex Portfolio Examples
📝Example 1: Mixed Account Optimization
Scenario: Alice in Ontario has a TFSA, RRSP, and taxable account.
TFSA: $1,000 Canadian dividends (no tax), $1,300 US dividends (15% withholding, no Canadian tax).
RRSP: $2,000 US dividends (no withholding, no tax now).
Taxable: $3,000 Canadian dividends (gross‑up & credit), $5,000 REIT distributions (30% ROC), $2,000 US dividends (fully taxed).
Result: Alice owes roughly $3,400 in tax. ROC simply defers tax until she sells her REIT.
📝Example 2: Heavy REIT Investor Over 5 Years
Scenario: Bob in BC holds $100k in REITs, earning $10k annually with 30–50% ROC.
Over 5 years, ROC reduces his ACB from $100k to $80k.
When he sells half his position for $70k, he realizes a $30k gain. At 50% inclusion and 47% marginal rate, he owes about $7,050.
Lesson: ROC tracking is critical — missing it means overpaying capital gains tax.
📝Example 3: High‑Income + Foreign Exposure
Scenario: Carla in Alberta earns $10k foreign dividends, $5k eligible dividends, and participates in an ESPP.
ESPP discount taxed as employment income; capital gains taxed at 50% inclusion.
Foreign dividends taxed at full rate but reduced by foreign tax credit.
Capital losses harvested to offset gains.
💡 Did You Know?
High earners benefit most from tax‑efficient account selection and loss harvesting.
Practical Tax Planning Tips
Maximize TFSA & RRSP before investing in taxable accounts.
Shelter high‑tax income like REITs, bonds, and foreign dividends inside registered accounts.
Reinvest your RRSP tax refund — instead of spending the refund you receive from RRSP contributions, reinvest it (perhaps into the RRSP or TFSA). This not only boosts compounding growth but also increases the tax deduction base for future years.
Track ACB meticulously to account for ROC and DRIPs.
Harvest capital losses to offset gains and reduce tax.
Mind contribution deadlines and distribution dates to optimize timing.
Comparison Table: Reinvested vs. Spent RRSP Tax Refund
Key Takeaways
Asset location matters: put the right income in the correct account.
Canadian dividends shine in taxable; REITs/bonds/foreign dividends fit better in TFSA/RRSP.
Control capital gains timing; harvest losses smartly.
Track ACB and read your T3/T5 slips carefully.
Reinvest RRSP refunds to maximize long-term compounding.