Fall 2005

F i n a n c i a l
Return of capital

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With their potential for capital appreciation and their regular distributions, a portion of which is sometimes tax-deferred, real estate investment trusts are becoming increasingly popular among investors. 

by Robert Kavanagh

With their potential for capital appreciation and their regular distributions, a portion of which is sometimes tax-deferred, real estate investment trusts (REITs) are becoming increasingly popular among investors. A REIT is essentially a trust that invests money, obtained through the sale of units to its investors, in various types of income-producing real estate properties.

How does the Adjusted Cost Basis (ACB) of an investment in REITs (and income trust units) differ from the ACB of an investment in “regular” mutual fund trusts?

The starting point for an ACB calculation of an investment is the cost of the initial purchase. The units’ weighted average cost is then used to compute the ACB, since the investor will purchase units at different unit costs throughout the investment’s holding period (similar to a mutual fund trust). However, to complicate matters, certain REIT units pay regular distributions, which are only partly taxable. For these REITs, part of the distribution represents a “return of capital,” which is the non-taxable portion of the distribution. Investors who hold REIT units will have to be alert as the ACB of their units will decrease by the amount of this return of capital.

The following table illustrates the computation of an investor’s ACB in a REIT. Assume that the December 31 distribution of $1.20 per unit was taken in cash and had a non-taxable portion of $0.50 per unit.



Purchase/ Sale Price

Transaction Value

ACB of Holdings

ACB/ Unit

Year 1, Jan 1 purchase






Year 1, Mar 1 purchase






Year 1, Dec 31 return of capital portion of the distribution taken in cash






Year 2, June 30 redemption






1The reduction in the ACB as a result of the December 31 distribution was determined as: $0.50 per unit x 1,500 units = $750.

2Assuming that the 500 units were redeemed at a value of $11.75, the unit holder realized a capital gain of $540: (500 units x $11.75) - $5,335 = $540.

3The ACB per unit of the units redeemed on June 30 was determined as: total amount paid, divided by the number of units = ACB per unit: $16,000 ÷ 1,500 = $10.67. Therefore, the total ACB of the units sold can be computed as: 500 units x $10.67 = $5,335. The ACB of the remaining holdings — $10,665 — is the difference between the ACB of 1,500 units less the ACB of the units sold: $16,000 - $5,335 = $10,665.

While the “tax-free” return of capital received on December 31 has translated into a higher taxable capital gain when the units were sold, the benefit is that only 50% of the capital gain was taxable.

Robert Kavanagh is a senior financial consultant with MD Management’s Newfoundland and Labrador regional office.



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