Equity markets are sharply down in 2022, so now is a good time to take a close look at your portfolio to get a head start on tax-loss selling for the year.
Tax-loss selling involves selling investments with accrued losses at year-end to offset capital gains realized elsewhere in your non-registered portfolio. Any net capital losses that cannot be currently used may be either carried back three years or carried forward indefinitely to offset taxable capital gains in other years.
Here are five things to keep in mind if you’re interested in doing some tax-loss selling.
Mind the trade deadline
In order for your loss to be available for 2022 (or one of the prior three years), the settlement must take place in 2022. This year, the trade date must be no later than Dec. 28, 2022, in order to complete settlement by Dec. 30, because Dec. 31 falls on a Saturday this year.
Look out for superficial losses
If you think your loser stock may rebound in the months ahead, you may be tempted to sell it, realize the capital loss and then buy it back again to catch the recovery. The problem with doing so is that you could get caught by the “superficial loss” rule if you buy back too soon.
The superficial loss rule applies if property (or an “identical property”) sold at a loss is repurchased within 30 days, and is still held on the 30th day by you or an “affiliated person.” An affiliated person includes your spouse or common-law partner, a corporation controlled by you, your spouse or partner, or a trust of which you, your spouse or partner is a majority-interest beneficiary, such as your registered retirement savings plan (RRSP) or tax-free savings account (TFSA).
Under the rules, your capital loss will be denied and added to the adjusted cost base (tax cost) of the repurchased security. That means any benefit of the capital loss can only be obtained when the repurchased security is ultimately sold.
Beware of currency implications
The United States dollar is up nearly nine per cent against the Canadian dollar in 2022, so if you purchased securities in U.S. dollars, the gain (or loss) may be larger (or smaller) than you anticipated once you take the foreign-exchange component into account.
For example, let’s say Sam bought 100 shares of a U.S. company in January 2022 when the price was US$100 per share and the U.S. dollar was trading at $1.26. The price of the shares has now fallen to US$95, and Sam decides he wants to do some tax-loss harvesting to use the US$500 accrued capital loss against gains he realized earlier this year.
Before knowing if this strategy will work, he’ll need to convert the potential U.S. dollar proceeds back into Canadian dollars. If the exchange rate today is US$1 equals $1.37, selling the U.S. shares for US$9,500 yields $13,015. There is a capital loss of US$500 (US$9,500 minus US$10,000), but there is a capital gain of $415, calculated as the Canadian dollar
proceeds of $13,015 less the Canadian-dollar-adjusted cost base of $12,600 (US$10,000 times 1.26).
If Sam had gone ahead and sold the U.S. stock, he would be doing the opposite of tax-loss selling and accelerating his tax bill by crystallizing the accrued capital gain in 2022.
Don’t contribute in-kind
If you’re convinced a particular stock or security you own may be currently underwater but has significant long-term potential, you may be tempted to transfer it with an accrued loss to your RRSP or TFSA to realize the loss without actually disposing of the investment. Be warned this loss is specifically denied under our tax rules.
Instead, consider selling the investment with the accrued loss and, if you have the contribution room, contributing the cash from the sale into your RRSP or TFSA. Then, if you are willing to wait at least 30 days to avoid the superficial loss rule discussed above, you can have your RRSP or TFSA “buy back” the investment.
You take some risk in that you’re out of the position for those 30 days, but you can use your capital loss and enjoy any future, long-term appreciation.
Use this spousal loss trick
Canada’s tax rules don’t allow spouses or common-law partners to file a joint return, but there may still be a way for one spouse or partner to use the other’s losses.
Consider the following scenario: Jill inherited some ABC Inc. shares years ago that now have an accrued capital gain of $10,000. She has no capital losses to shelter those gains should she sell the shares.
However, her husband Jack has a portfolio that sharply declined in 2022 and finds himself sitting on $10,000 of losses on his XYZ Corp. shares, which he originally acquired for $50,000 but are now worth $40,000. Unfortunately, Jack has no other gains this year nor did he have any gains in the prior three years that could be offset by this $10,000 loss.
Suppose Jack sells the XYZ shares on the open market and receives $40,000. The same day, Jill buys $40,000 of XYZ shares. As a result, Jack’s loss will be deemed superficial since Jill acquired the shares within 30 days of his disposition. That means the superficial loss of $10,000 is added to the adjusted cost base of Jill’s shares, bringing her new tax cost up to $50,000 ($40,000 plus the $10,000 superficial loss).
If Jill now waits 30 days before selling (assuming no further market declines in the value of XYZ stock), she will realize a capital loss of $10,000 (proceeds of $40,000 minus her adjusted cost base of $50,000), which can then be used to offset the accrued gain of $10,000 when her ABC shares are sold.
This strategy was blessed by the Canada Revenue Agency in a 2003 technical interpretation.