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Are your marijuana stocks growing like weeds? Make sure your profits don’t go up in smoke

by UFile Team Équipe ImpôtExpert | Mar 31, 2020   Comments:

ufile-blog-marijuana

With the legalization of marijuana in Canada, a whole new sector and a new set of companies are available to invest in.

The potential gains are limitless. However, they also come with a lot of risk. Read on to find out how you can minimize the downsides.

The promise of a new business sector

Since marijuana stocks are a new business, the potential gains you can get from investing in the right ones are huge. Total revenues from the sale of marijuana products will increase exponentially as these products become more mainstream. Therefore, this new sector should be the place to invest, right? How can you lose in a sector whose revenues can only increase?

Slow down there! Remember that when a new type of business gets into the market, there will always be growing pains. This has certainly been the case with marijuana stocks in Canada, which have been pummeled by the market.

Considering that this is a new industry, many of the companies within it will be new as well, which always comes with heightened risks. Historically, most new companies in the stock market, or Initial Public Offerings (IPO), do not perform well in their first years. Buyer beware!

How can I protect myself if I invest in this industry?

There are several tried and true investment techniques you can use to protect yourself while dipping your toe in the marijuana industry. For one, you can make sure that your portfolio is well diversified, with many stocks in many different sectors of the economy. This way, even if your investment loses money, your loss won’t be devastating to your finances.

If you want to invest in marijuana stocks but don’t know which one to pick, you can diversify your risk by choosing an Exchange Traded Fund (ETF) that has a basket of marijuana stocks. In Canada, companies that offer marijuana ETFs include Horizons and Evolve.

Another way of protecting yourself from a potential loss in these investments is by implementing a stop-loss order. Simply put, this is essentially a way of creating a floor for your investment. Through your broker, you plan in advance for a sell order in the event that your investment reaches a certain price, one that is below your purchase price. This way, if your investment drops significantly, you trigger the stop-loss sale and avoid a huge loss.

The tax implications

Considering the risky nature of this type of investment, how can you optimize it tax-wise? You have two options: you can either buy these investments in a taxable account, or in a tax-sheltered account like an RRSP or a TFSA. There are pros and cons to each approach.

Buying these risky stocks in a taxable account will make any future gains taxable. That’s the downside, especially if you hit the jackpot with some of these investments. This means that you will have additional income to declare on your tax return. However, since the gain will be considered a capital gain, the amount of income you will have to declare is only half of the gain/profit you made. You get to pocket the other half free of tax. At the opposite end, if you incurred a loss on these investments, then half of it becomes a deductible capital loss that can be used to reduce any taxable capital gains you have in the year. If you have more losses than gains in the year, you can carry them forward to a future year or apply them against your gains in any of the preceding three years.

For tax-sheltered accounts like RRSPs or TFSAs, any gains/profits made from the sale of these stocks or ETFs would not be taxable within those accounts. The gains will be tax-free in a TFSA, and tax-deferred in an RRSP. This is a distinct advantage over taxable accounts. The downside comes on the opposite end, when you incur a loss. In that case, you cannot deduct the loss against any taxable gains/profits you made in the year.

The following table summarizes the characteristics explained above.

Accounts

Pros

Cons

 

 

Taxable

 

Losses in the account are deductible against any capital gain in the current year, future years, and 3 prior years.

Gains/profits are only taxable at 50%.

 

 

 

Gains/profits are taxable in the year of sale; more taxes to pay.

 

 

Tax sheltered
(RRSP/TFSA)

Gains/profits are tax-free (TFSA) or tax-deferred (RRSP) within the account.

Losses within these accounts are not deductible against any capital gain.

 

You will have to carefully weigh the pros and cons to determine which type of account is right for you.

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