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. Please note the blog post is time sensitive and subject to
changes in legislation or law.
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