At this time of year, articles on tax loss selling become all the rage. Although I wrote a blog post on this topic last November, I was going to write a new post on this topic. However, after re-reading my blog post from last year; I thought to myself, it was really not half-bad, if I do say so myself. Thus, I have decided to just update my post on tax-loss selling from last year to reflect current dates and legislative changes. I have also added a paragraph on the potential capital gain that may arise on donated flow-through shares that were purchased after March 21, 2011.
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 2012 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; although this year, if the USA takes us to the fiscal edge at year-end, before they fall off their fiscal cliff, we all may have some unrealized capital losses closer to Christmas.
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 2012 will have to be reported on Schedule 3 of your 2012 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 2011 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 2009, 2010 and 2011 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 2009, 2010 and 2011.
3. For each of 2009-2011, 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 2010 or 2011, review whether you carried back those losses to 2009 or 2010 on form T1A of your tax return. If you carried back a loss to either 2009 or 2010, 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 2009 to 2011, you can potentially generate an income tax refund by carrying back a net capital loss from 2012 to any or all of 2009, 2010 or 2011.
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:
· 2012: realized capital loss of $30,000
· 2011: taxable capital gain of $15,000
· 2010: taxable capital gain of $5,000
· 2009: 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 2012 against the $7,000 and $5,000 taxable capital gains in 2009 and 2010, respectively, and apply the remaining $3,000 against your 2011 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 2011 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 2012 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2011. Alternatively, if you have capital gains in 2012, 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.
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 2012 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2012 and 2013, 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 2014 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
Speaking 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.
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.
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. However, both these scenarios should not be undertaken without first obtaining professional advice. If you intend to transfer losses this year, you must act quickly 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 2012 will be 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 2012 by December 24, 2012.
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.