If you’ve scanned your portfolio recently, you may have noticed a little more red – and less green – than usual.
You’ve got plenty of company. With rising interest rates sending utilities, telecoms, real estate investment trusts, banks and other rate-sensitive sectors down sharply this year, plenty of investors are sitting on unrealized capital losses.
But before you let all that red ink spoil your holiday cheer, consider that your stock market losses have a silver lining: They can save you money at tax time.
With the end of the year fast approaching, today I offer up a crash course in tax-loss selling, which is one of the easiest strategies for trimming your tax bill. But to avoid incurring the wrath of the Canada Revenue Agency, you have to follow a few simple rules. I’ll also discuss some tips that will help you avoid seller’s remorse if the losers you ditch later rise in price.
What is tax-loss selling?
If you own securities in a non-registered account that are trading below their adjusted cost base, you can sell them for a capital loss and use that loss to offset any realized capital gains you may have. You must first apply the loss against realized capital gains in the current year. Any remaining losses can be carried back up to three years, or forward indefinitely, to offset capital gains in other years and reduce your taxes.
When is the deadline?
For your capital loss to be recorded in the 2023 tax year, you must sell the security no later than Dec. 27. Stock trades take two days to settle – that is, for the shares and cash to actually change hands – so a trade entered on Dec. 27 will settle on Dec. 29, which is the last business day of 2023.
Any other dates to be aware of?
For the capital loss to be allowed by the CRA, you must wait at least 30 days before repurchasing the same shares. Otherwise, the CRA considers it a “superficial loss” and you won’t be able to use it for tax purposes. The rule – which also applies to identical securities bought in the 30 days before the sale – is designed to prevent investors from selling stocks and immediately repurchasing them strictly for the tax loss. And, no, you can’t get around the 30-day restriction by selling a stock in a non-registered account and immediately buying it in a registered account, or by having your spouse or common-law partner purchase it. These would also be considered superficial losses by the CRA.
But what if I still like the shares?
If you want to trigger a capital loss but still like the company’s prospects, you could wait 30 days and repurchase the shares. However, the danger is that the shares could appreciate while you’re out of the market, costing you potential gains. The risk of a rebound is not something to take lightly, especially now that interest rates appear to have peaked, removing a major headwind for markets.
One way to mitigate the risk is to buy a similar, but not identical, security whose performance is highly correlated with the one you sold. For example, you could sell Royal Bank (RY) for the loss and immediately buy Toronto-Dominion Bank (TD), then swap TD for Royal after 30 days (or continue to hold TD if it suits your investing goals).
Would the strategy work for ETFs?
Yes. You could buy an exchange-traded fund to temporarily take the place of a stock, or a different ETF, that you sold. For example, shares of First Quantum Minerals Ltd. (FM) have plunged more than 60 per cent this year as the government in Panama has cancelled the company’s contract to operate the massive Cobre Panama copper mine. In a recent ETF strategy note, National Bank Financial analysts recommended that investors who sell First Quantum for the tax loss could consider buying the Horizons Copper Producers Index ETF (COPP) to maintain exposure to the sector, before potentially repurchasing First Quantum after 30 days. Even though First Quantum is a component of the ETF, they are different securities and would therefore not violate the superficial loss rules.
Similarly, an investor who sells a real estate investment trust such as Northwest Healthcare Properties REIT (NWH.UN), whose unit price has been cut in half this year, could buy a fund such as the BMO Equal Weight REITs Index ETF (ZRE), which holds Northwest as one of its 22 constituents. If the REIT sector rebounds, the investor will participate in the gains instead of watching from the sidelines.
With hundreds of ETFs to choose from, investors can usually find a suitable fund to serve as a placeholder for the stock they sell. One thing to watch out for: If you’re selling one ETF for a tax loss and replacing it with another ETF, the two ETFs should not track the same index. Otherwise, it could be considered a superficial loss.
Closing thoughts
After a rocky year for stock markets, many investors will have opportunities for tax-loss selling. By following the rules and employing some simple strategies, you can turn the agony of stock market defeat into the thrill of tax-savings victory.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
John Heinzl