The calculator above models multi-year Return of Capital (ROC) distributions, tracks your running adjusted cost base decay, and identifies the exact tax year and dollar amount when subsection 40(3) deemed capital gains are triggered.
Many Canadian exchange-traded funds (ETFs), Real Estate Investment Trusts (REITs), split-share corporations, and covered-call funds distribute cash that is classified for tax purposes as Return of Capital (ROC), reported annually in Box 42 of your T3 tax slip.
Unlike taxable dividends or interest, ROC distributions are not taxed in the year you receive them. Instead, the CRA requires you to deduct every dollar of ROC from your running Adjusted Cost Base (ACB).
How Return of Capital Changes Your Cost Basis
Every positive Box 42 ROC adjustment reduces your total ACB without changing the number of shares or units you own:
New Running ACB = Previous ACB - Annual T3 Box 42 ROC New ACB per Share = ( New Running ACB ÷ Total Shares Held)
Over multiple years, these reductions can lower the ACB materially. When you eventually sell the investment, the capital gain will be higher, or the capital loss lower, than it would be without the adjustments.
The Section 40(3) Deemed Capital Gain Rule
A critical rule that catches many Canadian income and covered-call investors off guard is subsection 40(3) of the Income Tax Act:
An Adjusted Cost Base cannot be negative.
If an annual Return of Capital distribution exceeds your remaining ACB:
- The negative excess is immediately deemed a capital gain realized in that tax year.
- Your running ACB automatically resets to $0.00 CAD for future tax periods.
- You must report this deemed gain on CRA Schedule 3 even though you did not sell a single share.
Multi-Year Worked Example: From $15,000 Starting Cost to Deemed Gain
Consider an investor who purchases 1,000 units of a high-yield Canadian fund for $15,000.00 CAD ($15.00/ unit) and receives high Box 42 ROC distributions over three consecutive tax years:
| Tax Year | Beginning ACB | Box 42 ROC Received | Provisional Calculation | Section 40(3) Deemed Gain | Ending ACB | Ending ACB / Unit |
|---|---|---|---|---|---|---|
| 2024 | $15,000.00 | -$4,000.00 | $11,000.00 | $0.00 | $11,000.00 | $11.00/ unit |
| 2025 | $11,000.00 | -$6,000.00 | $5,000.00 | $0.00 | $5,000.00 | $5.00/ unit |
| 2026 | $5,000.00 | -$7,000.00 | -$2,000.00 | +$2,000.00 | $0.00 | $0.00/ unit |
The Tax Results:
- In 2024 and 2025, the investor pays zero tax on the ROC distributions, but their ACB drops from $15,000 to $5,000.
- In 2026, the $7,000 ROC exceeds the $5,000 remaining ACB.
- The $2,000.00 CAD negative excess is deemed a capital gain on the 2026 tax return. At an illustrative 50% inclusion rate, the taxable portion would be $1,000 CAD.
- The ending ACB for 2027 resets to $0.00 CAD. Any future ROC received in 2027 will be 100% deemed capital gain.
How to Report a Deemed Gain on CRA Schedule 3
When a deemed capital gain occurs under subsection 40(3), the CRA instructs taxpayers holding mutual fund trust units to complete Schedule 3 as follows:
| Schedule 3 field | Line number | Value to enter | Treatment |
|---|---|---|---|
| Total proceeds | Line 13199 | $0.00 CAD | There was no actual sale of units. |
| Total capital gain | Line 13200 | Deemed gain amount (for example, $2,000.00) | Reports the negative ACB amount as a deemed gain. |
| Taxable portion | Schedule 3 calculation | Apply the inclusion rate for the tax year | The resulting taxable net capital gain flows to T1 line 12700. |
Reconcile the adjustment to broker records
When you eventually sell units that have experienced years of ROC reductions, compare T5008 Box 20 with the full history of Box 42 and other fund adjustments. CRA says Box 20 may or may not reflect ACB, so neither the slip nor a separate ledger should be accepted without reconciling the supporting records. The T5008 reconciliation checker compares the two and shows the dollar difference.
If an applicable ROC adjustment is missing from ACB, the reported capital gain will be understated or the loss overstated. Keep the reconciliation with the T3 slips, fund tax data, and transaction history used in the calculation.
Scope note: This calculator models multi-year ROC cost decay for a single security holding. For a single reinvested capital gains distribution, use the ETF phantom distribution calculator . For annual T3 distribution adjustments and pooled cross-brokerage ACB ledgers, see ETF adjustments in myCostBase . For full pre-filing tax checklists, see the Canadian Adjusted Cost Base Checklist .
Frequently asked questions: Return of Capital & Negative ACB Calculator
What is Return of Capital (ROC) in Canadian ETFs and REITs?
Return of Capital (reported in Box 42 of your T3 tax slip or Box 132 of a T5013) is a non-taxable distribution of your own invested capital rather than income or capital gains. Because it is not taxed in the year received, Canadian tax law requires you to subtract ROC from your running Adjusted Cost Base (ACB), which increases your capital gain (or decreases your loss) when you eventually sell the security.
What happens when my ACB drops below zero in Canada?
Under subsection 40(3) of the Income Tax Act, an Adjusted Cost Base cannot remain negative. The moment a Return of Capital distribution reduces your ACB below $0.00, the negative portion is immediately deemed a taxable capital gain in that tax year. Your running ACB then automatically resets to $0.00.
How do I report a negative ACB deemed capital gain on Schedule 3?
For trust units, CRA says to enter the deemed capital gain on Schedule 3 line 13200 and zero proceeds on line 13199 because there was no actual sale. The new adjusted cost base of the units is deemed to be zero. Use the inclusion rate and Schedule 3 instructions applicable to the tax year.
Do brokerage platforms track Return of Capital and negative ACB correctly?
Do not assume the broker figure is automatically correct or incorrect. CRA says T5008 Box 20 may or may not reflect adjusted cost base. Reconcile the figure to T3 Box 42 and the fund’s tax information, particularly for units held over multiple years or transferred between accounts.
What happens if I buy more shares after triggering a deemed capital gain?
Because your ACB reset to $0.00 following the deemed gain, any new purchases simply start a new cost basis from $0.00. For example, if you buy 100 more shares at $20.00, your new total ACB is $2,000.00 CAD across all your shares.