It was an eerie experience to be speaking on Tuesday at a financial conference in New York City. The conference was being held at a midtown hotel, just three blocks from the Lehman Brothers' headquarters, where employees were seen lugging out their belongings.
Of course, much of the conference buzz was dedicated to the carnage from the credit crunch on Wall Street.
But there may be a silver lining for investors stuck holding depressed stocks and mutual funds: tax-loss selling.
Usually, tax-loss selling is done in December, just before year-end. But given the events of this past week, now might be an ideal time to realize some losses.
The strategy is actually quite simple: If you own securities that have gone down in value, you may wish to sell them to realize a capital loss.
A capital loss must first be applied against any capital gains in the current year. Once current-year capital gains have been used, the balance of the loss can either be carried back to offset capital gains in any of the three prior years (2005, 2006 or 2007) or be carried forward indefinitely to offset capital gains in future years.
The strategy may be ideal for BCE investors who face massive capital gains on their holdings of the Bell Canada parent. This summer, the company finalized an agreement with a group led by the Ontario Teachers' Pension Plan to take the company private, exposing non-registered investors --many who have held the stock for decades -- to a significant tax bill for 2008.
Realizing losses on other positions may be an ideal way to shelter those BCE gains from tax.
Investors who wish to hold on to those losers in the hopes of a longer-term recovery can still engage in tax-loss selling by selling the stock, realizing the loss, and buying it back again.
The key to making this strategy work, however, is to watch out for the "superficial loss" rule. A superficial loss occurs when you sell property for a loss and buy it back within 30 days. The rule also applies if your spouse or partner (or a corporation controlled by you or your spouse or partner) buys it back within 30 days.
If you get caught by the superficial loss rule, your capital loss will be denied and added to your adjusted cost base (tax cost). That means you can still realize the benefit of the loss, but only when you ultimately sell the investment.
Thinking about realizing the loss through your RRSP -- either as a contribution or as a swap for an asset already inside your plan?
Be forewarned that a loss on such a transfer will be denied. Instead, consider selling the investment outside your RRSP, realizing the loss and contributing the cash from the sale into your RRSP. Wait 30 days to avoid application of the superficial loss rules and then buy back the original investment inside your RRSP.
Note that the loss-denial rule will apply to in-kind contributions to the Tax Free Savings Account (TFSA), beginning in 2009.