End Of Year Tax-loss selling

Original post by John Heinzl – Investment Reporter at the The Globe and Mail. Tax-loss selling: If you’re dumping your dogs, read this first

The holiday season is fast approaching and people’s thoughts are naturally turning to friends, family … and that other cherished year-end tradition: tax-loss selling.

What is tax-loss selling, in what circumstances should you do it, and what are some potential traps to watch out for? That’s the subject of today’s column.

What is it?

Tax-loss selling is a strategy that investors employ to reduce their tax bill. If you own shares that have dropped in value since you bought them, you can sell the shares and use the capital loss to offset any capital gains you may have. You must first apply the loss against capital gains recorded in the current year. If you still have net losses left over, you can carry them back up to three years or forward indefinitely to offset capital gains in those years. Only losses incurred on non-registered assets qualify, so if a stock has dropped inside your registered retirement savings plan (RRSP), for example, you can’t use it for a tax loss.

What should I sell?

Often, the best candidates for tax-loss selling are companies that have run into trouble and are unlikely to recover soon, if ever – stocks you would probably be selling anyway. If you believe a stock will rebound, you should think carefully before selling and potentially missing out on the recovery. Generally, it’s best to consider investment fundamentals first, and tax consequences second. In other words, don’t let the tax tail wag the investment dog.

Is there a deadline?

Yes, and it may be sooner than you think. For a loss to count in the current year, the trade has to settle on or before Dec. 31. Because the settlement date is three business days after the trade date, and because Christmas Day and Boxing Day are statutory holidays, the last day for tax-loss selling of Canadian stocks this year is Dec. 24. If you sell after that date, the loss will be recorded for tax purposes in the following year.

Can I sell and then repurchase the same stock?

You have to be careful here. If you sell a stock and repurchase it within 30 days (before or after the sale date), the Canada Revenue Agency considers it a “superficial loss” and you won’t be able to use it to offset capital gains. Furthermore, you can’t get around the rule by repurchasing the same stock in a different account such as an RRSP or tax-free savings account (TFSA), or by having your spouse – or a corporation controlled by you or your spouse – repurchase it. The idea is that you can’t claim a tax loss if you, or someone affiliated with you, maintains control of the shares. The simplest solution is to wait 30 days before repurchasing the same stock.

Are there any creative strategies to avoid a “superficial loss”?

Yes. Say you own an energy stock that’s plunged in value because the price of oil has tumbled. You want to trigger the capital loss, but you’d like to maintain exposure to the energy sector because you think the long-term outlook is positive. One solution is to sell the stock, and then immediately purchase a different, but similar, energy company. Alternatively, you could sell the stock and buy an energy mutual fund or exchange-traded fund. In both cases, you would be entitled to use the capital loss to offset capital gains because you aren’t repurchasing an identical security.

What about transfers to RRSPs and TFSAs?

If you transfer shares in kind from a non-registered account to a registered account, you are deemed to have sold the shares at their fair market value. That means, if the shares have appreciated, you will report a capital gain. However, if the shares have dropped in value, you won’t get to claim the capital loss (who said life is fair?). In such circumstances, it may be best to sell the shares and contribute the cash to the registered account, in which case the loss would be allowed. If desired, you could then purchase a similar security inside the registered account or wait 30 days and repurchase the same security.