My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, November 24, 2014

Tax Loss Selling - 2014 Version

For the fourth 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 updating dates and the third paragraph, there is very little that is new in this post from last years version.

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 2014 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 process is more critical than usual this year, as the markets were very strong until the fall and you may have some large realized capital gains in 2014 (let alone large capital gains from 2013 for which you maybe able to carryback any 2014 losses) to offset.

I would like to provide one caution in respect of tax loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes, with the intention of re-purchasing those stocks and one or two of the stocks take off during the 30 day wait period and the cost to repurchase is far in excess of their tax savings. Thus, you should first and foremost consider selling your "dog stocks" that you and/or your advisor no longer wish to own. If you then need to crystallize additional losses, be wary if you are planning to sell and buy back the same stock.

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.

Reporting Capital Gains and Capital Losses – The Basics


All capital gain and capital loss transactions for 2014 will have to be reported on Schedule 3 of your 2014 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 suggest you should start your preliminary planning immediately. These are the steps I recommend you undertake:

1. Retrieve your 2013 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 2011, 2012 and 2013 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 2011, 2012 and 2013.

3. For each of 2011-2013, 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 2012 or 2013, review whether you carried back those losses to 2011 or 2012 on form T1A of your tax return. If you carried back a loss to either 2011 or 2012, 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 2011 to 2013, you can potentially generate an income tax refund by carrying back a net capital loss from 2014 to any or all of 2011, 2012 or 2013.

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:

· 2014: realized capital loss of $30,000

· 2013: taxable capital gain of $15,000

· 2012: taxable capital gain of $5,000

· 2011: 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 2014 against the $7,000 and $5,000 taxable capital gains in 2011 and 2012, respectively, and apply the remaining $3,000 against your 2013 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 2013 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 2014 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2013. Alternatively, if you have capital gains in 2014, 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) . 

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 2014 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2014 and 2015, 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 2016 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.

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 their 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. From a timing perspective, you may wish to consider this option for next year, given the above hold restrictions.

Settlement Date


It is my understanding that the settlement date for stocks in 2014 will be Wednesday 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 2014 by December 24, 2014.

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.

5 comments:

  1. Thanks for the description but I am still a little confused by the example you gave under the Basic Uses of Losses section. I understand why you take half of the loss to apply against the gains but aren't only half of the gains taxable as well? Asked another way, if I have $5000 in taxable gains that I want to completely offset do I need $5000 in taxable losses or $10000?

    ReplyDelete
    Replies
    1. Hi Anon

      It is just terminology. The total capital gain (or realized gain) is the gross gain. The taxable gain is 1/2 of that amount. ie: you sell shares for $1,000 that you paid $200. The capital gain or realized gain is $800, but the taxable gain is $400

      In your example, if you have $5,000 in taxable gains, that means you had $10,000 in capital or realized gains before application of the 1/2 rule. Thus, you need $10,000 in capital losses or $5,000 in taxable ($10,000 x 1/2)

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  2. My accountant only recorded (in schedule 3 & in aggregate) the total of my gains (in procceds) and total of my losses (in ACB) giving me my Loss/gain. So I may have traded 20 stocks with a total ACB of $170,000 and total proceeds of $175,000 for all trades, but he would write only my gains and loss giving me the same result.

    EX- ACB 27,500 - Proceeds $32,500 = Cap gain $5000 (rather than ACB $170,000 - Proceeds $175,000 = Cap gain $5000)

    I was partially responsible for my accountant doing it that way, as I did not give him my total ACB’s & Proceeds, only the losses and gains. (my notes to him would say “ Telus -Gain $1100, BCE- Loss $400 etc….) He has reported this way for the last 6 years, and the CRA has never questioned it, but going forward, and now that I'm doing it myself, I want to make sure that I do it properly.

    Can you please tell me if reporting the larger numbers is the way to go? or if I can continue to report the way my accountant used to?

    I do keep detailed records of every stock that I trade, and I keep them all on file for future reference or a possible audit.


    thanks for your help

    ReplyDelete
    Replies
    1. Hi Anon

      The correct way is the actual proceeds and the actual cost, however, I have seen many people and some accountants just use the net gain/loss. However, I would suggest you do it the correct way, would make life easier if ever audited.

      Delete
  3. Thanks, I appreciate you taking the time to help me!

    ReplyDelete