The days are getting shorter and the temperature is falling, which means everyone's favourite time of year is almost here.
Halloween? Christmas? No, tax-loss selling season.
With the S&P/TSX composite down more than 7 per cent year-to-date and many energy and commodity stocks suffering far steeper losses, investors who want to harvest losses for tax purposes will have no shortage of candidates this year.
Today, we'll go over the basics of tax-loss selling and also cover some of the finer points so you don't incur the wrath of the Canada Revenue Agency when you dump your dogs.
What is tax-loss selling?
The purpose of tax-loss selling is to cut your tax bill. If you own a stock, mutual fund, exchange-traded fund or other security that has depreciated in value since you bought it, selling the investment triggers a capital loss. You can then use the loss to offset any capital gains you may have, thereby reducing your total tax hit. The strategy only applies to non-registered (i.e. taxable) accounts; there is no benefit to triggering a loss in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA), for example.
What capital gains can be offset?
When you trigger a capital loss, you must first apply it against capital gains in the current year. If you still have capital losses left over, you can carry them back up to three years or forward indefinitely to offset taxable capital gains in those years. (For the former, complete Form T1A, Request for Loss Carryback; to use a loss from a previous year, claim it on line 253 of your return.) Your CRA notice of assessment shows your net capital losses (based on an inclusion rate of 50 per cent) for the current year and your unused net capital losses from previous years; add them together to get your total net capital losses available.
Can I buy back the security right away?
No. If you sell a security and repurchase it within 30 calendar days after (or before) the settlement date of the sale, the CRA considers it a "superficial loss" and you can't use it to offset capital gains. Nor can you skirt the rule by repurchasing the security in an RRSP, TFSA or other account, by purchasing options on the same security, or by having your spouse – or a corporation controlled by you or your spouse – repurchase the security. Basically, the rules are designed to prevent you from claiming a tax loss if you, or someone affiliated with you, maintains control of the investment.
What if I still like the security?
If you still like the investment's prospects and are concerned that the price might rebound during the 30-day window, you could purchase a similar – but not identical – security to hold during the waiting period. For example, say you own an oil producer that you want to sell for the tax loss, but you're worried that the price of crude might rise before you can repurchase the shares. One strategy is to purchase a different oil producer, or perhaps an energy ETF, whose performance is correlated with the stock you sold. You could then claim a loss, but you would also participate if energy stocks in general rise (or fall). After the 30-day period, you could sell the second security and repurchase the original stock that you sold. Keep in mind: ETFs that track the same index are considered identical securities in the eyes of the CRA, even if they are managed by different ETF providers.
When is the tax-loss selling deadline?
For a sale to count in the current year, the trade must settle on or before Dec. 31. The settlement date is three business days after the trade date. Because the stock market is closed on Friday, Dec. 25 (for Christmas) and Monday, Dec. 28 (in lieu of Boxing Day), the last day to enter a tax-loss sale for settlement in 2015 is Thursday, Dec. 24.
What about transferring shares to an RRSP or TFSA?
If you transfer shares from a non-registered account to a registered account, you are deemed to have sold the shares at their fair market value. 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. In such cases, it may be best to sell the shares and contribute the cash to the registered account, in which case the loss would be allowed.
Because many people are sitting on unrealized losses this year, share prices could come under pressure as investors engage in tax-loss selling. So, you might want to think twice before selling at a price that seems unduly low. As always, consider the fundamentals of your investment first, and the tax consequences second.