Written by Troy Peart
In recent times, the performance of stock markets all over the world have been tumultuous at best. As a result, it is highly likely that some of the investments that one owns could be worth substantially less than what they paid for them. Although buying something that decreases in value should never be the objective when investing, even the most highly regarded investors sometimes experience the pain of investing in assets that decline in value. Fortunately, a strategy called “tax-loss selling” could be the silver lining of an otherwise dark cloud.
Tax-loss selling involves selling a security (including mutual funds) for less than one originally paid for it. From a taxation standpoint, this creates a capital loss which can then only be deducted against capital gains (as opposed to any other form of income) that were realized during the year. If there are not sufficient realized capital gains in the year in which capital losses are triggered, these capital losses can be carried backwards for up to 3 taxation years (2007, 2006 or 2005) or carried forward indefinitely.
The key to making this strategy work, however, is to ensure that one does not fall prey to the “superficial loss” rules. A superficial loss is deemed to have occurred if a security is sold for a loss and both of the following occur:
1) The identical property is acquired or re-acquired during the period beginning 30 days before the disposition and 30 days after the disposition of the original security;
AND
2) At the end of the above period, the identical property is still held
If the superficial loss rules apply, then the loss will be denied and the cost base for tax purposes will be equal to the new cost plus the disallowed loss (this is also equal to the original cost). For example, if the superficial loss rules applied and an individual that purchased a stock for $10 and sold it for $7 (before repurchasing it); the new cost for tax purposes would be $10 rather than the $7 it was repurchased for. If this individual then eventually sold this security for $16, there would only be a $6 taxable capital gain rather than the $9 capital gain that would have occurred had the superficial loss rules not applied. It is also important to note that the superficial loss rules will apply if the identical security is repurchased: by one’s spouse, a corporation which they (or their spouse) control or if the security is repurchased in an RRSP or Tax Free Savings Account.
Tax loss selling is an effective tool that can be employed to minimize one’s current and future taxes or to even recoup taxes that were paid in previous years. If an individual had an unusual year in which significant capital gains were realized, capital losses could be quite advantageous. If there are more capital losses in a given year than capital gains, it often makes sense to simulate various scenarios in order to assess which one provides the most tax relief. Like all other financial and tax planning strategies, one should ensure that tax loss selling is considered within the context of an individual’s overall goals. Professional advice should be considered to ensure that one maximizes the opportunities available to them.
Troy Peart B.B.A., CFP, CFA can be emailed at troypeart@shaw.ca.
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