For the third year in a row, I am posting a blog on tax loss selling. I am doing it again because the topic is very timely and every year around this time, people get busy with holiday shopping and forget to sell the “dogs” in their portfolio and as a consequence, they pay unnecessary income tax on their capital gains in April. Additionally, while most investment advisors are pretty good at contacting their clients to discuss possible tax loss selling, I am still amazed each year at how many advisors do not discuss the issue with their clients. So if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options (if you have to initiate the contact, consider that a huge black mark against your advisor). For full disclosure, other than the "missing dividend section" and updating dates, there is very little that is new in this post.
I would suggest that the best stock trading decisions are often not made while waiting in line to pay for your child’s Christmas gift. Yet, many people persist in waiting until the third week of December to trigger their capital losses to use against their current or prior years capital gains. To avoid this predicament, you may wish to set aside some time this weekend or next, to review your 2013 capital gain/loss situation in a calm methodical manner. You can then execute your trades on a timely basis knowing you have considered all the variables associated with your tax gain/loss selling.
This
blog post will take you through each step of the tax-loss selling
process. In addition, I will provide a planning technique to create a
capital gain where you have excess capital losses and a technique to
create a capital loss, where you have taxable gains.
All capital gain and capital loss transactions for 2013 will have to be reported on Schedule 3 of your 2013 personal income tax return. You then subtract the total capital gains from the total capital losses and multiply the net capital gain/loss by ½. That amount becomes your taxable capital gain or net capital loss for the year. If you have a taxable capital gain, the amount is carried forward to the tax return jacket on Line 127. For example, if you have a capital gain of $120 and a capital loss of $30 in the year, ½ of the net amount of $90 would be taxable and $45 would be carried forward to Line 127. The taxable capital gains are then subject to income tax at your marginal income tax rate.
If you have a net capital loss in the current year, the loss cannot be deducted against other sources of income. However, the net capital loss may be carried back to offset any taxable capital gains incurred in any of the 3 preceding years, or, if you did not have any gains in the 3 prior years, the net capital loss becomes an amount that can be carried forward indefinitely to utilize against any future taxable capital gains.
I am posting this blog earlier than most year-end capital loss trading articles because I believe you should start your preliminary planning immediately. These are the steps I recommend you undertake:
1. Retrieve your 2012 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information may also be accessed online if you have registered with the Canada Revenue Agency.
2. If you do not have capital losses to carryforward, retrieve your 2010, 2011 and 2012 income tax returns to determine if you have taxable capital gains upon which you can carryback a current year capital loss. On an Excel spreadsheet or multi-column paper, note any taxable capital gains you reported in 2010, 2011 and 2012.
3. For each of 2010-2012, review your returns to determine if you applied a net capital loss from a prior year on line 253 of your tax return. If yes, reduce the taxable capital gain on your excel spreadsheet by the loss applied.
4. Finally, if you had net capital losses in 2011 or 2012, review whether you carried back those losses to 2010 or 2011 on form T1A of your tax return. If you carried back a loss to either 2010 or 2011, reduce the gain on your spreadsheet by the loss carried back.
5. If after adjusting your taxable gains by the net capital losses under steps #3 and #4 you still have a positive balance remaining for any of the years from 2010 to 2012, you can potentially generate an income tax refund by carrying back a net capital loss from 2013 to any or all of 2010, 2011 or 2012.
6. If you have an investment advisor, call your advisor and request a realized capital gain/loss summary from January 1st to date to determine if you are in a net gain or loss position. If you trade yourself, ensure you update your capital gain/loss schedule (or Excel spreadsheet, whatever you use) for the year.
Now that you have all the information you need, it is time to be strategic about how to use your losses.
For discussion purposes, let’s assume the following:
· 2013: realized capital loss of $30,000
· 2012: taxable capital gain of $15,000
· 2011: taxable capital gain of $5,000
· 2010: taxable capital gain of $7,000
Based on the above, you will be able to carry back your $15,000 net capital loss ($30,000 x ½) from 2013 against the $7,000 and $5,000 taxable capital gains in 2010 and 2011, respectively, and apply the remaining $3,000 against your 2012 taxable capital gain. As you will not have absorbed $12,000 ($15,000 of original gain less the $3,000 net capital loss carry back) of your 2012 taxable capital gains, you may want to consider whether you want to sell any “dogs” in your portfolio so that you can carry back the additional 2013 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2012. Alternatively, if you have capital gains in 2013, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.
Where you have a large capital loss carryforward from prior years and it is unlikely that the losses will be utilized either due to the quantum of the loss or because you are out of the stock market and don’t anticipate any future capital gains of any kind (such as the sale of real estate), it may make sense for you to purchase a flow-through limited partnership (be aware; although there are income tax benefits to purchasing a flow-through limited partnership, there are also investment risks) .
Purchasing a flow-through limited
partnership will provide you with a write off against regular income
pretty much equal to the cost of the unit; and any future capital gain
can be reduced or eliminated by your capital loss carryforward.
For example, if you have a net capital loss carry forward of $75,000 and
you purchase a flow-through investment in 2013 for $20,000, you would
get approximately $20,000 in cumulative tax deductions in 2013 and 2014,
the majority typically coming in the year of purchase. Depending upon
your marginal income tax rate, the deductions could save you upwards of
$9,200 in taxes. When you sell the unit, a capital gain will arise. This
is because the $20,000 income tax deduction reduces your adjusted cost
base from $20,000 to nil (there may be other adjustments to the cost
base). Assuming you sell the unit in 2015 and you have a capital gain of
say $18,000, the entire $18,000 gain will be eliminated by your capital
loss carry forward. Thus, in this example, you would have total
after-tax proceeds of $27,200 ($18,000 +$9,200 in tax savings) on a
$20,000 investment.
Prior to March 22, 2011, you could donate your publicly listed flow-through shares to charity and obtain a donation receipt for the fair market value ("FMV") of the shares. In addition, the capital gain you incurred [FMV less your ACB (ACB is typically nil or very low after claiming flow-through deductions)] would be exempted from income tax. However, for any flow-through agreement entered into after March 21, 2011, the tax benefit relating to the capital gain is eliminated or reduced. Simply put (the rules are more complicated, especially for limited partnership units converted to mutual funds and an advisor should be consulted), if you paid $25,000 for your flow-through shares, only the gain in excess of $25,000 will now be exempt and the first $25,000 will be taxable.
So if you are donating flow-through shares to charity this year, ensure you speak to your accountant as the rules can be complex and you may create an unwanted capital gain.
One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchase an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and added to the cost base of the new shares acquired.
In certain cases you can use the superficial loss rules to your benefit. As per the discussion in my blog Capital Loss Strategies if you plan early enough, you can essentially use the superficial rules to transfer a capital loss you cannot use to your spouse. A quick blog recap: if you sell shares to realize a capital loss and then have your spouse repurchase the same shares within 30 days, your capital loss will be denied as a superficial loss and added to the adjusted cost base of the shares repurchased by your spouse. Your spouse then must hold the shares for more than 30 days, and once 30 days pass; your spouse can then sell the shares to realize a capital loss that can be used to offset your spouse’s realized capital gains. Alternatively, you may be able to just sell shares to your spouse and elect out of certain provisions in the Income Tax Act.
Both these scenarios are complicated and subject to missteps, thus, you should not undertake these transactions without first obtaining professional advice. If you intend to transfer losses this year, you must act quickly (you only have ten or so days to get this done) to ensure you are not caught by the 30 day hold period and the settlement date issue noted below.
It is my understanding that the settlement date for stocks in 2013 will be Tuesday December 24th. Please confirm this date with your broker, but assuming this date is correct, you must sell any stock you want to crystallize the gain or loss in 2013 by December 24, 2013.
As discussed above, there are a multitude of factors to consider when tax-loss selling. It would therefore be prudent to start planning now, so that you can consider all your options rather than frantically selling via your mobile device while sitting on Santa’s lap in the third week of December.
I would suggest that the best stock trading decisions are often not made while waiting in line to pay for your child’s Christmas gift. Yet, many people persist in waiting until the third week of December to trigger their capital losses to use against their current or prior years capital gains. To avoid this predicament, you may wish to set aside some time this weekend or next, to review your 2013 capital gain/loss situation in a calm methodical manner. You can then execute your trades on a timely basis knowing you have considered all the variables associated with your tax gain/loss selling.
Reporting Capital Gains and Capital Losses – The Basics
All capital gain and capital loss transactions for 2013 will have to be reported on Schedule 3 of your 2013 personal income tax return. You then subtract the total capital gains from the total capital losses and multiply the net capital gain/loss by ½. That amount becomes your taxable capital gain or net capital loss for the year. If you have a taxable capital gain, the amount is carried forward to the tax return jacket on Line 127. For example, if you have a capital gain of $120 and a capital loss of $30 in the year, ½ of the net amount of $90 would be taxable and $45 would be carried forward to Line 127. The taxable capital gains are then subject to income tax at your marginal income tax rate.
Capital Losses
If you have a net capital loss in the current year, the loss cannot be deducted against other sources of income. However, the net capital loss may be carried back to offset any taxable capital gains incurred in any of the 3 preceding years, or, if you did not have any gains in the 3 prior years, the net capital loss becomes an amount that can be carried forward indefinitely to utilize against any future taxable capital gains.
Planning Preparation
I am posting this blog earlier than most year-end capital loss trading articles because I believe you should start your preliminary planning immediately. These are the steps I recommend you undertake:
1. Retrieve your 2012 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will reported. This information may also be accessed online if you have registered with the Canada Revenue Agency.
2. If you do not have capital losses to carryforward, retrieve your 2010, 2011 and 2012 income tax returns to determine if you have taxable capital gains upon which you can carryback a current year capital loss. On an Excel spreadsheet or multi-column paper, note any taxable capital gains you reported in 2010, 2011 and 2012.
3. For each of 2010-2012, review your returns to determine if you applied a net capital loss from a prior year on line 253 of your tax return. If yes, reduce the taxable capital gain on your excel spreadsheet by the loss applied.
4. Finally, if you had net capital losses in 2011 or 2012, review whether you carried back those losses to 2010 or 2011 on form T1A of your tax return. If you carried back a loss to either 2010 or 2011, reduce the gain on your spreadsheet by the loss carried back.
5. If after adjusting your taxable gains by the net capital losses under steps #3 and #4 you still have a positive balance remaining for any of the years from 2010 to 2012, you can potentially generate an income tax refund by carrying back a net capital loss from 2013 to any or all of 2010, 2011 or 2012.
6. If you have an investment advisor, call your advisor and request a realized capital gain/loss summary from January 1st to date to determine if you are in a net gain or loss position. If you trade yourself, ensure you update your capital gain/loss schedule (or Excel spreadsheet, whatever you use) for the year.
Now that you have all the information you need, it is time to be strategic about how to use your losses.
Basic Use of Losses
For discussion purposes, let’s assume the following:
· 2013: realized capital loss of $30,000
· 2012: taxable capital gain of $15,000
· 2011: taxable capital gain of $5,000
· 2010: taxable capital gain of $7,000
Based on the above, you will be able to carry back your $15,000 net capital loss ($30,000 x ½) from 2013 against the $7,000 and $5,000 taxable capital gains in 2010 and 2011, respectively, and apply the remaining $3,000 against your 2012 taxable capital gain. As you will not have absorbed $12,000 ($15,000 of original gain less the $3,000 net capital loss carry back) of your 2012 taxable capital gains, you may want to consider whether you want to sell any “dogs” in your portfolio so that you can carry back the additional 2013 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2012. Alternatively, if you have capital gains in 2013, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.
Creating Gains when you have Unutilized Losses
Where you have a large capital loss carryforward from prior years and it is unlikely that the losses will be utilized either due to the quantum of the loss or because you are out of the stock market and don’t anticipate any future capital gains of any kind (such as the sale of real estate), it may make sense for you to purchase a flow-through limited partnership (be aware; although there are income tax benefits to purchasing a flow-through limited partnership, there are also investment risks) .
Donation of Flow-Through Shares
Prior to March 22, 2011, you could donate your publicly listed flow-through shares to charity and obtain a donation receipt for the fair market value ("FMV") of the shares. In addition, the capital gain you incurred [FMV less your ACB (ACB is typically nil or very low after claiming flow-through deductions)] would be exempted from income tax. However, for any flow-through agreement entered into after March 21, 2011, the tax benefit relating to the capital gain is eliminated or reduced. Simply put (the rules are more complicated, especially for limited partnership units converted to mutual funds and an advisor should be consulted), if you paid $25,000 for your flow-through shares, only the gain in excess of $25,000 will now be exempt and the first $25,000 will be taxable.
So if you are donating flow-through shares to charity this year, ensure you speak to your accountant as the rules can be complex and you may create an unwanted capital gain.
Superficial Losses
One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchase an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and added to the cost base of the new shares acquired.
Disappearing Dividend Income
Every year, I ask at least one or two clients why their dividend income is lower on their personal tax return. Typically the answer is, "oops, it is lower because I sold a stock early in the year that I forgot to tell you about". Thus, if you manage you own investments; you may wish to review your dividend income being paid each month or quarter with that of last years to see if it is lower. If the dividend income is lower because you have sold a stock, confirm you have picked up that capital gain in your calculations.
Creating Capital Losses-Transferring Losses to a Spouse Who Has Gains
In certain cases you can use the superficial loss rules to your benefit. As per the discussion in my blog Capital Loss Strategies if you plan early enough, you can essentially use the superficial rules to transfer a capital loss you cannot use to your spouse. A quick blog recap: if you sell shares to realize a capital loss and then have your spouse repurchase the same shares within 30 days, your capital loss will be denied as a superficial loss and added to the adjusted cost base of the shares repurchased by your spouse. Your spouse then must hold the shares for more than 30 days, and once 30 days pass; your spouse can then sell the shares to realize a capital loss that can be used to offset your spouse’s realized capital gains. Alternatively, you may be able to just sell shares to your spouse and elect out of certain provisions in the Income Tax Act.
Both these scenarios are complicated and subject to missteps, thus, you should not undertake these transactions without first obtaining professional advice. If you intend to transfer losses this year, you must act quickly (you only have ten or so days to get this done) to ensure you are not caught by the 30 day hold period and the settlement date issue noted below.
Settlement Date
It is my understanding that the settlement date for stocks in 2013 will be Tuesday December 24th. Please confirm this date with your broker, but assuming this date is correct, you must sell any stock you want to crystallize the gain or loss in 2013 by December 24, 2013.
Summary
As discussed above, there are a multitude of factors to consider when tax-loss selling. It would therefore be prudent to start planning now, so that you can consider all your options rather than frantically selling via your mobile device while sitting on Santa’s lap in the third week of December.
The blogs posted on The Blunt Bean Counter provide
information of a general nature. These posts should not be considered specific advice;
as each reader's personal financial situation is unique and fact specific.
Please contact a professional advisor prior to implementing or acting upon any
of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to
changes in legislation or law.
Interesting, I'd never heard of these flow-through partnerships. My understanding is that they cannot be practically sold until they convert into mutual funds, which takes ~2 years? Is the conversion date set from the outset, or unknown? It sounds like potentially a great option for someone near or in retirement with capital losses they don't expect to be able to use, but I would be concerned about the risk of the underlying investment, since resources can obviously be volatile. Do you have first-hand (or second-hand I guess as the accountant) experience using these? I don't suppose there's some kind of 'perfect' solution where you could use the flow-through partnership for the tax benefit, and simultaneously hedge against the underlying resource exposure?
ReplyDeleteHi Nathan:
DeleteYes, they convert after approximately 2 years, I dont recall if the exact date is known beforehand, I think the prospectus just says they will be converted without a specific date, however, i do not remember for sure.
I have both first and second hand experience. They must first and foremost be viewed as investments, however, depending upon your portfolio, they may fill a portfolio small cap or O&G void and thus the tax savings may be advantegous without much portfolio risk. However, if they are bought soley for tax purposes and not to fill an O&G or small cap portion of your portfolio, then you should not let the tax tail wag the dog, but ensure the investment and tax ramifications make sense.
I really have not looked into the hedge aspect, you would need to ask your advisor or determine that yourself. In a case of capital losses that you do not anticipate ever using, flow throughs should be seriously considered.