What is selling at a loss for tax purposes?
This tax strategy consists of realizing a capital loss by selling a non-registered investment at a value below its acquisition cost: stocks, bonds, mutual funds or exchange-traded funds that have experienced a sharp decline during the year.
When capital losses are realized, they can be deducted from the capital gains generated in the same taxation year, thereby reducing the taxpayer's tax burden.
In a context where markets are particularly unpredictable, the possibility of realizing capital losses by selling and acquiring similar assets offers the additional benefit of remaining active, while having the opportunity to rebalance the portfolio.
Who can take advantage of this strategy?
This strategy is available to investors who wish to reduce their capital gains tax liability by disposing of investments that have accumulated losses by year-end.
It is important to carefully review your portfolio to identify investments that have generated losses that could be offset by capital gains realized in the same year.
What you need to know
This tax strategy has some important rules.
The Income Tax Act (ITA) limits 50% the amount of realized loss that can be considered a tax-deductible capital loss. This capital loss can potentially be used to reduce the calculation of taxable income.
If no capital gains are realized in the current year, the capital losses can be deducted from the previous three years or any future year.
The ITA also states the “superficial loss" rule, also known as the "30-day rule." This rule prevents an investor or their affiliated persons from deducting a capital loss realized as a result of the sale of a security when the same security is repurchased within 30 days before or after the sale.
 The ITA specifies that the purchase period is the “period that begins 30 days before the disposition and ends 30 days after that disposition."
Within the prescribed period, investors or their affiliated persons may not buy or sell identical securities with a view on realizing a loss for tax purposes. Beyond this period, the investor is allowed to buy back these same securities, without nullifying the capital loss.
The ITA defines persons affiliated with an individual as follows:
- Individuals are deemed to be affiliated with themselves
- Spouses and common-law partners are deemed to be affiliated with each other
- A corporation controlled by an individual (or their spouse) is deemed to be a person affiliated with the individual.
There are several other tax rules where the financial expertise is key.
Many investors have diversified portfolios that include exchange-traded funds (ETFs). Let's take a look at how this type of investment can be beneficial.
Within the superficial loss rule, ETFs allow you to take advantage of market rebounds. Subject to certain conditions, it is possible to sell and buy back units in ETFs with a similar, but not identical, benchmark. These transactions are sensitive and depend on whether or not the investments are considered identical according to a set of relatively complex criteria. Here again, the expertise of the financial advisor is essential.
Illustration of selling at a loss for tax purposes
|Purchase of 100 units at $10 = $1,000
||100 units sold when the price has fallen to $7 = $700||
|Purchase of 100 units of an $8 ETF = $800
||Value of ETF units = $10|
|Realized loss = ($1000 - $700) $300||Potential gain = ($2 x 100) $200|
Investor with year-end options.
The ability to apply capital losses on capital gains realized in the current year or the previous three years, or to carry them forward indefinitely, is an undeniable advantage.
When it comes to tax strategies, each situation is unique. There are no tax rules applicable to everyone. Investors wishing to use a tax loss selling strategy should consult a tax specialist.
For example, for the sale at a loss to be applicable to the current taxation year, the financial advisor will ensure that the execution of the transaction meets the deadlines with the settlement date usually effective two business days after the sale.
After analyzing the file, the advisor will propose the sale at a loss for tax purposes or other strategies depending on the economic situation and the investor’s situation. Optimizing portfolio performance goes hand in hand with regular consultation with an investment professional.
For some information, such as tax history or capital loss carry-forward balance, the Canada Revenue Agency (CRA) is an excellent source.
The right time
The end of the year is the right time to consider the tax loss selling strategy. In some cases and under certain conditions, it can reduce the tax burden by selling unperforming investments at a loss and using those losses to offset taxable gains on other investments.
Remember that capital losses can be profitable. Hence the importance of reminding investors to be well informed and, above all, to be well advised throughout the year!