Triggering tax losses to cut your tax bill

This was a tough year for investors, with financial markets resembling something of a roller coaster ride, as trade disputes, central bank actions, Brexit, and various geopolitical stresses drove investor sentiment. As a result, active traders are likely to have some losses showing up in their portfolios. But there is a silver lining: This is a good opportunity for a year-end tax strategy known as "tax-loss selling." Triggering losses does not necessarily mean that your pocketbook will be lighter, because any losses that you realize can help offset your 2019 tax bill on capital gains made when the roller coaster was heading up. Here are some pointers to take advantage of the art of tax-loss selling.

First, a quick summary of the rules:

1. Current-year capital losses offset current-year (i.e., 2019) capital gains, if any. To the extent that you have capital gains in 2019, this claim is mandatory. You cannot pass up claiming 2019 losses against 2019 gains.

2. If, after applying your 2019 capital losses against 2019 gains, there is an excess loss and you had taxable capital gains between 2016 and 2018, you can file for a tax refund. This offset is optional, and you can choose the year in which to apply the losses.

3. 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 going back to 2016, there is no rush to go out and claim a tax loss.

When it comes to these rules, consider the following:

* Settlement dates: To claim an investment tax loss in 2019, the trade must actually "settle" by December 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" this year, you should consider December 24 as the last trading day because 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" – that is, payment made and security documents delivered on the trade date – you may have until later in the month. But be sure to check with your advisor well in advance.

* Don't be afraid to shelter profits. 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.

* 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.

* When not to claim a loss. One example of when you may wish to pass up claiming a loss carryback is if you were in a lower tax bracket in earlier years than you expect to be in the near future and when you expect to have capital gains. Although capital losses can be carried forward indefinitely, i.e., to be applied against future capital gains, the farther 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 2020, 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. One exception to this strategy is if you expect to move into a higher tax bracket next year.

Finding your losses

When hunting for losses, check to see whether you incurred capital losses in a previous year that you have never used. This is quite possible, because deductions for capital losses can be claimed only against capital gains, and unclaimed capital losses can be carried forward indefinitely. If you don't have back records, another idea is to contact the Canada Revenue Agency to request your personal "carryforward balances."

Other possibilities for tax losses include bad loans (for example, such items as bad mortgage investments, junk bonds, a no-good advance to your company, bad loans to a business associate, and on).

Finally, if you're of a "certain age," check your 1994 return to see if you have made the "last chance" election to take advantage of the now defunct $100,000 capital gains exemption. For most investments, this will result in an increase to the cost base of the particular item. If your gain is on a mutual fund and you made the election on it, you may have a special tax account  known as an "exempt capital gains balance," which can be used to shelter capital gains from the fund until the end of this year, after which it must be added to the cost base of the particular investment.

Previously published in The Fund Library on December 5, 2019 by tax and estate planning lawyer,  Samantha Prasad. Portions of this article first appeared in  The TaxLetter, © 2019 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.