The fourth quarter is typically the time of year to review your portfolio for securities that have dropped in value and have a capital loss, which can then be sold and used against capital gains. This approach is known as Tax-Loss Selling and is a legitimate way for investors to reduce their income taxes while rebalancing their portfolio. This strategy only works for securities held outside of a registered account – i.e. TFSAs, RRIFs, RESPs, RRSPs, LIRAs, etc. don’t qualify. Before implementing such a strategy, there are some things you need to know.
Any security (ETF, stock, bond, mutual fund) sold cannot be repurchased immediately as the CRA would disallow the loss if the same security was repurchased within thirty days or less, even if it was purchased in a different account or through your spouse. To compensate for this rule, a substitute security would be purchased for these thirty days so any gains can be captured during this period.
At the same time, the above rule can work to your benefit in certain circumstances. If one spouse, let’s call them Spouse1, has a capital loss and the other spouse, Spouse2, has a capital gain in the year or has had capital gains in the prior three years, you can legitimately transfer the capital loss to the other spouse by selling the security with a loss and have the other spouse purchase the same security. The tax rules state that Spouse1’s capital loss is denied, however the loss increases the adjusted cost base (ACB) of Spouse2.
For example, Spouse1 owns a security with a cost of $15,000 and the current market value is $10,000. Spouse1 sells the security for $10,000, for a loss of $5,000. Spouse2 then purchases the same security within 30 days for $10,000. The $5,000 loss is denied for Spouse1, however, Spouse2’s ACB increases by $5,000 to $15,000. Spouse2 then sells the security for $10,000 in 31+ days (assuming the market price hasn’t changed) for a loss of $5,000. This loss can be applied in the current year to offset other capital gains or carried back up to three years against capital gains in those years.
Even if you don’t have capital gains this year, you can carry them back three years and apply to gains you’ve already paid tax on, or you can carry them forward indefinitely.
If you are considering contributing securities in-kind that have a capital loss to your TFSA or RRSP, the capital loss cannot be claimed to offset a capital gain. This rule is buried deep inside CRAs regulations and can easily be overlooked. It is more advantageous to sell the security to capture the loss, then contribute the net proceeds and invest in a substitute security for the next thirty days.
Tax loss selling is a strategy we use to maintain your asset allocation while utilizing the tax rules to minimize your taxes. For example, we may sell an ETF of the S&P/TSX 60 if it is in a loss position and purchase a similar ETF of the S&P/TSX 60 from a different provider, such as iShares, Horizons, etc. Thus, the capital loss is triggered while maintaining the portfolio’s overall asset allocation.
A trade must settle in the same calendar year in order to be used to be used for the current tax year, therefore, don’t forget to factor in the holidays at the end of the year and that trades now take two days to settle. With the recent introduction of two day settlement, this gives one more day to trade; the last day of the year to sell a security is Monday, December 28th.
The Bottom Line
While it never feels good to have a security in your portfolio that has lost money, tax loss selling is a prudent tax strategy when done properly and should be periodically reviewed throughout the year and not just at year end. Feel free to contact one of our Wealth Consultants if you have any questions about your personal financial situation.
- Andrew Brydon, CPA, CA