While half of capital gains are taxed in a non-registered account, there is no tax on capital gains in a TFSA. Capital gains in an RRSP are fully taxed when withdrawn in retirement along with income and original contributions, but investors are permitted to deduct their contributions from their taxable income.Amy Mitchell/iStockPhoto / Getty Images
Selling stocks at a loss before year-end provides savvy investors the opportunity to offset taxes on capital gains – and that strategy can be particularly valuable for those who have contribution space available in their registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs).
Tax-loss selling permits capital losses from equity investments to be applied against capital gains going back up to three years or into the future indefinitely. Half of the capital gains in a non-registered trading account are taxed, so half of the capital losses can eliminate the taxes on capital gains on a dollar-for-dollar basis. Dec. 27 is the deadline to trigger a capital loss for the 2019 taxation year.
“I’ve seen people butcher this [strategy],” says Karen Slezak, tax partner at Toronto-based law firm Crowe Soberman LLP’s tax group.
Many investors fail to adhere to the superficial loss rules that apply to tax-loss selling, which prohibit investors or an affiliated person – even their spouses – to repurchase the same stock within 30 days, she says.
In fact, much of the misunderstanding of the superficial loss rules comes from investors striving for further tax savings by contributing the proceeds from a tax-loss sale to an RRSP or TFSA, Ms. Slezak says.
“The superficial loss rules do apply to TFSA and RRSPs. If you sold a stock you can’t buy back that same stock within 30 days. That’s whether or not you [then buy it for] your TFSA or RRSP. Otherwise, you’re going to lose the capital loss,” she says.
That said, for investors who do obey the superficial loss rules, shifting money from a non-registered account to registered accounts such as TFSAs and RRSPs is a great way to get a further tax bonus – especially starting in the new year when the total TFSA contribution limit is expanded by $6,000, she says .
“You can sell in December, hold off and make a contribution in January so it’s a 2020 contribution,” she says.
While half of capital gains are taxed in a non-registered account, there is no tax on capital gains in a TFSA. Capital gains in an RRSP are fully taxed when withdrawn in retirement along with income and original contributions, but investors are permitted to deduct their contributions from their taxable income. Contributions made before March 3, 2020 can be deducted from 2019 income or carried forward to future years. In both cases, capital losses don’t apply from a tax perspective because capital gains are never taxed directly in the first place.
Lorn Kutner, tax consultant at Toronto-based Northwood Family Office says that transferring proceeds from a tax-loss sale in a non-registered account to a registered account is a great tax strategy.
“If it were me and I had room in a TFSA or RRSP, I would rather put it in a registered account because my future income and gains would be tax-free [or tax-deferred],” he says.
There are many reasons investors would trade outside a registered account to begin with. Some would rather pay the capital gains tax than be taxed fully on RRSP withdrawals. Older Canadians with trading accounts before the TFSA was launched in 2009 might not have available room in their TFSAs. And some employers with equity compensation programs only offer shares in non-registered accounts. In other cases, investors might just not know tax savings are greater in a registered account.
For investors torn between putting their tax-loss proceeds into a TFSA or RRSP, Mr. Kutner says it depends on the individual investor. He says some might not like the withholding tax on early RRSP withdrawals or the possibility of forced minimum withdrawals in a high tax bracket in retirement. On the plus side, investments in an RRSP are allowed to grow tax-free until withdrawn. Investments in a TFSA, on the other hand, can be withdrawn at any time with no tax consequences.
“I would look at the RRSP as a retirement vehicle” he says. “If you’re going to need [the money] in the foreseeable future, put it in a TFSA.”
From an investment perspective, Mr. Kutner says it really doesn’t matter. However, he cautions investors not to base their decisions entirely on tax efficiency.
“It should be an investment decision first. You don’t want the tax tail wagging the investment dog,” he says.
For investors deciding whether to put their tax-loss selling proceeds into a TFSA or RRSP, the decision could be much easier if their contribution room in either vehicle has been used up. Both have limits. Starting in the new year, the total cumulative TFSA space will be $69,500 for those who were at least 18 years of age when the vehicle was introduced in 2009. The contribution limit for RRSPs is 18 per cent of the previous year’s earned income to a maximum of $26,500. Unused RRSP space can be carried forward to future years.
In both cases the Canada Revenue Agency provides current personal contribution limits in annual Notice of Assessments from individual tax returns and for individual taxpayers who set up CRA online accounts.