’Tis the season for tax-loss selling in Canada
With 2023’s year-end fast approaching, late December is a critical period for Canadian investors and their money managers. Now that we’re in the fourth quarter, this is the time to take inventory of your investments—and specifically taxable non-registered investment accounts—with an eye to minimizing tax before it’s too late.
For Canadian investors who have achieved significant taxable capital gains, now is the time to implement a tax-loss selling strategy—the most effective way to find tax savings.
What is tax-loss selling in Canada?
Tax-loss selling is an investing strategy designed to offset taxable capital gains and reduce your tax bill. It involves selling investments to trigger a capital loss and claiming them against capital gains.
Definition of tax-loss harvesting
Tax-loss harvesting, or tax-loss selling, is a strategy for reducing tax in non-registered accounts. Investors sell money-losing investments, triggering capital losses they can use to offset capital gains incurred the same year. Tax losses can also be carried back three years or carried forward indefinitely. When using this strategy to save on taxes, take care to avoid triggering the superficial loss rule.
Read the full definition of tax-loss harvesting in the MoneySense Glossary.
Capital gains and capital losses
In Canada, when you sell appreciable assets such as stocks, bonds, precious metals, real estate, or other property for more than the purchase price of the investment plus any acquisition costs—a.k.a. the adjusted cost base (ACB)—this is called a capital gain.
The math is pretty straightforward. If you bought a stock for $100 and sold it for $200, the capital gain is $100. The Canada Revenue Agency (CRA) requires you to report the capital gain as income on your tax return for the year the asset was sold. And, 50% of its value is considered taxable, based on the rate of your income tax bracket.
In this example, the taxable income is $50 ($100 x 50%), which is taxed at your marginal tax rate. The CRA does not tax capital gains inside registered accounts such as registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs).
On the flip side, when you sell an investment for less than its ACB, this is considered a capital loss. The CRA allows Canadian taxpayers to use capital losses to offset any capital gains.
Unlike capital gains, capital losses can be reported on your tax return in any of the three years prior to the loss or to offset future capital gains. Capital losses have no expiration date.
As an investment advisor in Canada, I track my clients’ portfolios throughout the year to have a clear view of their capital gains’ position and opportunities to minimize tax. That’s when tax-loss selling comes into play.
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Tax-loss selling, explained
It’s important to be strategic in selecting the investments you want to sell. For example, you may want to target an investment you no longer have confidence in or that is no longer in line with your financial objectives and risk profile.
What is a superficial loss in the eyes of the CRA?
You may also want to select an investment that’s down today and likely won’t immediately move up in price but has strong long-term growth potential. The goal here is to repurchase the asset and avoid missing out on future gains. However, if you repurchase the asset within 30 days, the CRA will deem this a superficial loss and you will not be able to claim it as a capital loss.
Bottom line: Be sure to wait the required 30 days before buying back the investment.
Benefits of implementing a tax-loss selling strategy
Implementing a tax-loss selling strategy can help you:
- Offset capital gains and reduce the amount of tax you pay on taxable investments,
- Leverage losses in your portfolio minimizing any negative impact,
- And reduce future taxes.
Implementing a tax-loss selling strategy also presents Canadian investors with an opportunity to rebalance their portfolios. It’s timely, especially for 2023 when technology has been the predominant driver of all the market gains. It’s a chance to ensure the asset mix in your portfolio accurately reflects your risk tolerance and investment objectives.
Who should implement a tax-loss selling strategy
Every investor has specific needs and there are several considerations to take into account when deciding to implement a tax-loss selling strategy. These include:
- Your risk profile,
- Investment objectives,
- Income level,
- Marginal tax rate,
- And the impact the capital gain and capital loss will have on your tax bill and portfolio.
For example, if you are in a low tax bracket, capital appreciation likely trumps minimizing the amount of tax you have to pay. If you are going to trigger a capital loss, the trade has to be completed at least a week in advance of year-end to ensure it’s in time for the CRA to record it.
What happens to the markets in November and December
Be prepared for a short-lived pullback in the markets as individual and institutional investors alike are selling and taking capital losses. Historically, November and December have been good to investors and any selloff likely won’t have long-lasting or deep effects on the markets’ overall performance.
Read more about investing strategy:
- What Canadian investors can do in times of world crisis and war
- Attention, Canadian investors—the “Magnificent Seven” stocks are dominating
- How recession fears are shaping investor behaviour and emotions
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