Tax-loss selling to offset gains
The last year and a half was a rough time for investors and businesses alike, as the markets and economy were on a downward spiral due to the pandemic and other global factors. So chances are that your portfolio or financial statements might be reflecting some losses. But triggering losses does not necessarily mean that your pocketbook is lighter, because any losses that you realize can help offset your 2021 tax bill. Here's a look at how to take advantage of tax losses.
You have a capital loss when you sell, or are considered to have sold, a capital property for less than its adjusted cost base plus the outlays and expenses involved in selling the property. For tax purposes, a capital loss can only be used to offset against a capital gain (when you sell a capital property for more than its adjusted cost base plus outlays and expenses). But there are some key rules to keep in mind:
- Claim current-year losses first. Current-year capital losses offset current-year (i.e., 2021) capital gains, if any. To the extent that you have capital gains in 2021, this claim is mandatory: You cannot pass up claiming 2021 losses against 2021 gains.
- Look for prior-year losses next. If, after applying your 2021 capital losses against 2021 gains, there is an excess loss and you had taxable capital gains between 2018 and 2020, you can file for a tax refund. This offset is optional, and you can choose the year to apply the losses.
- Use older tax losses or carry them forward. If, after applying the above two rules, you still have excess capital losses after the carryback, you can carry them forward forever. This means that if you don't have gains this year or back to 2017, there is no rush to go out and claim a tax loss.
When it comes to these rules, consider the following:
- Take applicable losses now. To claim an investment tax loss in 2021, the trade must actually "settle" by Dec. 31. The settlement delay on Canadian stock exchanges is three trading days after the date of the sell order. To be sure that you don't miss the last possible "settlement date," you should consider Dec. 24 as the last trading day since it is likely that the Canadian stock exchanges will be closed on the Dec. 25 and 26. (Different rules may apply in the U.S.; and if the transaction is a "cash sale" – payment made and security documents delivered on the trade date – you may have until later in the month.)
- Rebalance portfolios. You may have been thinking of realigning your investment portfolio by taking your profits. If paying capital gains tax on your winners has deterred you, sheltering these by letting go of your losers could be a tax-smart strategy.
- Watch for surprise gains. Make sure that there isn't a surprise gain this year, for example, if you hold a mutual fund outside your RRSP and it sells off some winners. If you have potential tax losses, you may want to place a call to the mutual fund's manager to see if there'll be some capital gains in store this year.
- Check your tax bracket. You may wish to pass up claiming a loss carryback if you were in a lower tax bracket in earlier years than you expect to be in the near future and you expect to have capital gains. Although, capital losses can be carried forward indefinitely – i.e., to be applied against future capital gains – the further into the future your capital gain is, the lower the "present value" of your capital loss carryforward. So if capital gains are a long way off, it might be better to apply for a carryback and get the benefit of a tax refund now – even if you were in a relatively low tax bracket.
If you intend to sell off an investment for a capital gain around year end, you may want to defer the gain to 2022, because you can postpone the capital gains tax for a year. Note: You don't have to actually wait until the new year to do this, as long as you sell after the year-end settlement deadline (see discussion above). One exception to this strategy can occur if you expect to move into a higher tax bracket next year.
Do you really have a tax loss?
You probably are thinking that there's a good likelihood that you are sitting on at least a couple of losses. However, don't assume this is the case. So the first question to ask yourself is whether you actually have a tax loss to begin with. This depends on the tax cost of your investment (i.e., the "adjusted cost base"). One important thing to bear in mind is that you must calculate your tax cost on a weighted-average basis for all identical investments.
Let's say that you bought 2,000 shares of Xco at $20 per share and another block of 1,000 shares of Xco at $40. Suppose that you also decided to take your lumps on the second purchase and you sold the block of 1,000 at $30. Your loss would be $10 a share, right? Wrong!
You have to calculate your cost on the weighted-average basis. Since most of your shares were bought when the stock was below its selling price, the weighted-average cost per share would be $36.67, that is, (2000 x $20 + 1000 x 40)/3,000. So that apparent $10 loss would turn into a $3.33 gain per share. You must use this approach even if you used a different broker for each purchase.
Happily, though, initial purchases by other family members will not figure into the weighted-average calculation. For this reason, it may make sense to have other family member make the initial purchases in order to "isolate" cost base in each person. In the previous example, if your spouse had purchased the second block at $40 and had sold it, your spouse's adjusted cost base would have been based on the $40 amount.
Previously published in The Fund Library on December 1, 2021, by tax lawyer, Samantha Prasad. Portions of this article first appeared in The TaxLetter, ©2021 by MPL Communications Ltd. Used with permission.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.