Given market conditions, you may occasionally find investments in your non-registered investment portfolio that are in an inherent loss position. These losses can represent an opportunity to use a tax-loss selling strategy.
Here are some tips and traps to avoid when actioning a tax-loss selling strategy.
Why you may want to trigger a loss
Sometimes certain conditions or priorities make realizing an investment loss the best choice. For example, you may not feel the underlying investment will likely recover, you may want to reallocate the funds to an alternative investment and rebalance your portfolio, or you may require cash to fund your lifestyle.
Regardless of the reasoning, once realized, the loss can be an opportunity to offset gains. A capital loss must first be used against capital gains, if any, in the current year. If there are no net capital gains in the current year, the capital loss can either be carried back and applied against capital gains in any of the three preceding years or carried forward to apply against capital gains in any future year.
How you may trigger a loss
The easiest way to trigger a capital loss would be to sell the investment on the exchange on which it is traded.
If you want to start transferring wealth to your adult children, consider transferring the investment as a gift or a sale for fair market value (FMV) consideration to an adult child. However, as discussed below, you cannot transfer the investment to your spouse and realize the capital loss.
Watch out for the superficial loss rules
Initially, you may think you can dispose of the investment, realize the capital loss and immediately reacquire the same investment, all while taking advantage of the capital loss to offset past, current, or future capital gains.
The superficial loss rules look 30 days in the past and 30 days in the future. If an identical property is acquired during this 61-day period, which includes the sale date, and you continue to hold the repurchased investment on the 30th day following the sale, the capital loss will be denied. The superficial loss rules apply not only to your actions; your capital loss may be denied if any affiliated individual repurchases the same investment. An affiliated person includes your spouse or common-law partner (partner), a company controlled by you and/or your partner, and a trust in which you or your partner are a majority interest beneficiary.
If the superficial loss rules apply, the denied capital loss is added to the repurchased investment’s adjusted cost base (ACB). It is, therefore, not available to offset capital gains.
What is an identical property?
The concept of identical property is important to understand before you begin realizing capital losses in your non-registered investment portfolio. So, what is an identical property? They are properties that are the same in all material respects so that a prospective buyer would not have a preference for one as opposed to another. To determine whether properties are identical, it is necessary to compare the inherent qualities or elements which give each property its identity, which must be decided based on the relevant details of your particular situation.
The most basic example is shares of the same corporation: shares of ABC Inc. are identical to shares of the same class of ABC Inc. A more complex example relates to mutual fund trust units, as the underlying asset mix of various investments can be identical despite having a different fund name.
The moral of the identical property story is to always check with your tax advisor to ensure that your efforts to realize a capital loss on a particular property will not be thwarted by the unintentional acquisition of an identical property within the superficial loss rules time period.
Efficient capital loss selling planning for married and common-law couples
The ways the superficial loss rules can potentially have a negative impact on an intended tax-loss selling transaction were discussed above; however, these rules can also be used to the advantage of your overall household tax liability.
For example, Mr. Y and Mr. X are common-law partners planning a big vacation, which they will require funds to pay for. Mr. Y has shares of GHI Inc. that he has held for many years with an FMV of $10,000 and an ACB of $5,000, resulting in an unrealized capital gain of $5,000. Mr. X has shares of DEF Inc. that he bought earlier in the year for $20,000 that have declined in value and are now worth $15,000, resulting in an unrealized capital loss of $5,000. Mr. X’s portfolio has pervasively declined in value, so he does not have any unrealized capital gains that he may realize to offset the inherent capital loss in DEF Inc., nor does he have any realized capital gains in any of the three previous years.
If Mr. X sells his shares of DEF Inc. to Mr. Y for FMV, he will receive $15,000, either in cash or as a promissory note receivable, carrying an interest rate of at least the prescribed rate, as set by the Canada Revenue Agency. As Mr. X and Mr. Y are common-law partners, they are affiliated; therefore, the superficial loss rules will deny the capital loss to Mr. X and add it to the ACB of the DEF Inc. shares now owned by Mr. Y as long as Mr. Y continues to hold the DEF Inc. shares for at least 30 days after they are acquired from Mr. X. Mr. Y now has shares with an ACB of $20,000 and an FMV of $15,000 and may sell the shares on the open market to realize the inherent capital loss. Mr. Y may then utilize the capital loss against the inherent capital gain when he sells his GHI Inc. shares in a tax-neutral transaction to obtain the necessary funds to pay for the vacation.
Verify your adjusted cost base
Before finalizing your trade in hopes of realizing a capital loss, it is advisable to verify the ACB of the securities you intend to dispose of. You may think your ACB is simply the amount you paid for the securities in question; however, many factors may impact your ACB.
If you purchased the security over time, note that your ACB needs to be calculated as a weighted average ACB. You cannot select specific securities you bought at a higher price and sell those under the assumption that their ACB is the same as the amount you paid to purchase those securities. This also applies to securities held in separate non-registered accounts – you must calculate your weighted average ACB for a security across all non-registered accounts you own.
You also need to be aware of any corporate reorganizations that may have taken place, as these can significantly impact your securities’ ACB. Another item to watch out for is return of capital received, which will reduce your securities’ ACB. On the other hand, if you own securities set up for dividend reinvestment, this will generally increase your securities’ ACB.
Be mindful of the trading deadline
You may be planning to offset losses very near the end of the year. While this generally does not pose any issues, you must be mindful of the delay in trade settlement after the trade order has been placed. The trade settlement date, not the trade order date, is relevant for tax purposes. Generally, it takes two business days from the trade date to settle a trade on Canadian and U.S. securities exchanges.
The last day to place a trade order varies by year. Consult our tax due date calendar or your Scotia Wealth Management wealth advisor for this year’s trading deadline.
Watch the currency impact
The U.S. currency can fluctuate significantly. Therefore, an investment in U.S. dollars that may look like it is in a capital loss position may not be. For example, assume Ms. Z purchased shares in a U.S. company for USD$1,000 on January 3 when the Canada / U.S. exchange rate was $1.2751. At this exchange rate, the ACB of the U.S. company shares is CAD$1,275. Ms. Z decided she would look at tax-loss selling, and on November 1, she sold the shares of the U.S. company, which had decreased in value to USD$960. On November 1, the Canada / U.S. exchange rate was 1.3609, which would result in proceeds in Canadian dollars of CAD$1,307. While there is a capital loss of USD$40 ($960-$1,000) before the shares’ cost and proceeds are converted to Canadian currency, once the ACB and the proceeds are converted at the appropriate exchange rates, there is actually a capital gain of $32 ($1,307-$1,275).
While this example is for illustrative purposes, it highlights the importance of converting both the ACB and the potential proceeds of a disposition at the relevant spot rate on the day of acquisition and disposition, respectively, to ensure that once converted, a capital loss will indeed be realized.
Summary
Everyone’s situation is unique, and not all general tax planning opportunities may benefit every person. Speak with your own tax advisor for further discussion and analysis and before implementing any tax planning strategies.
source https://rosenbergdri.ca/tax-loss-selling-planning-considerations-turning-a-negative-into-a-positive/
Dri Financial Group 