It’s the time of year that we hear a lot about tax-loss selling. But for the bulk of Canadians who invest in their registered retirement savings plans (RRSP) and tax-free saving accounts (TFSA), the tax-saving tool does not apply. But for investors with equities outside of RRSPs and TFSAs, and contribution space to spare, there is a way to take advantage of both tax breaks. Here’s how:

What is tax-loss selling?

Tax-loss selling allows you to offset realized capital gains with realized capital losses. If you sold assets and realized capital gains in the year and you are holding other assets in a non-registered account with unrealized losses, you may want to consider selling those securities to take advantage of the tax savings that may be offered by tax-loss selling.

When is the best time to consider tax-loss selling?

Tax-loss selling usually takes place at year-end, when an investor knows his or her net taxable capital gains for the year. Any capital losses realized during the year offset any realized capital gains in that year for a net capital gain or loss. A net capital gain is taxable in the year, while a net capital loss may be carried back three years or carried forward indefinitely to apply against net capital gains.

In order to take advantage of tax-loss selling, the selling transaction must settle on or before the last business day of the year. You can apply the realized capital loss against any capital gains realized in the current year. Any capital losses that cannot be used in full may either be carried back to offset net capital gains realized in the previous three years, or you can carry the losses forward indefinitely to offset net capital gains in future years.

What are some other important restrictions?

1. Superficial Loss Rule – If you sell a security to trigger a loss, and you or an affiliated person (e.g., your spouse, a corporation you control, or a trust where you have a major beneficial interest, including an RRSP and TFSA) purchases an identical security within 30 calendar days before or after the sale date, and you or the affiliated person still own that security 30 days after the sale date, the capital loss will be denied. This rule also applies if you or the affiliated person buys an option or right to buy the security that was sold.
2. Identical Securities – Shares of competing companies within the same industry should not be considered “identical securities” for purposes of the superficial loss rule, whereas index funds which track the same index would be considered “identical securities” under the rules. Professional tax advice will be needed to determine whether similar mutual funds are considered identical securities.

What are some common tax-loss selling strategies?

Given the complexities involved in tax-loss selling, professional tax advice is always recommended. Below are some strategies that can be considered when speaking to your tax advisor about tax-loss selling.

1. Listed Securities – Sell securities into the market and use the proceeds to calculate loss.
2. Delisted Securities – A security delisted from a stock exchange does not, in itself, mean that the company no longer carries on a business or that the Fair Market Value (FMV) of its shares is zero.
3. Shares Of Bankrupt Or Insolvent Corporations – If the company is bankrupt, winding up, or insolvent, and it is not carrying on any business either directly or indirectly through a subsidiary, you may elect to have a deemed disposition of the shares for no proceeds (e.g., zero dollars). This triggers a capital loss of your remaining Adjusted Cost Base (ACB) and the superficial loss rule will not apply. If, during the 24 months following the date of election, the corporation (or a corporation controlled by the corporation) resumes business activities, you must recognize a capital gain equal to the capital loss, re-establishing the old ACB.
4. Other Securities – If no market exists for a security and the security is not a share of a bankrupt or insolvent corporation, the security must still be sold at Fair Market Value to trigger a capital loss. If selling to an arm’s length buyer, the actual purchase price will be considered the FMV. If selling to a non-arm’s length buyer (e.g., a relative), the onus is on you to prove the FMV based on recent bid and ask prices, or on a proper business valuation. If the buyer of the security is your spouse or another affiliated person, the superficial loss rule applies and the capital loss will be denied. The transaction should be accompanied by a written Sale/Purchase Agreement, which clearly identifies the buyer and seller (including Social Insurance Numbers). The Agreement should also state what is being sold, the agreed upon price and a settlement date before year-end. In addition, it is important to retain all supporting documentation used in assessing the FMV. The securities can then be transferred to the buyer’s account or certificates given to the buyer.

The Allan Bush Investment Team Waterloo, is humbled and thankful to look after the financial wellbeing of so many families. As always, we’re here to answer any tax-loss selling questions you may have and professional tax advice is helpful.