What is tax-loss selling?
Also often referred to as tax-loss harvesting, this strategy involves selling non-registered investments, such as mutual funds or exchange-traded funds (ETFs), that are held in non-registered accounts and are valued below their purchase cost to create a capital loss. This capital loss can be deducted from capital gains realized in the same tax year, thereby reducing the tax payable.
It does not apply to registered investments, such as those held in an RRSP or TFSA, since capital losses and gains generated in these accounts are not subject to tax.
What are its benefits?
The tax benefits of tax-loss selling primarily include the ability to reduce the taxpayer's tax burden by deducting capital losses from capital gains realized in the same tax year. This strategy allows investors to offset realized capital gains against capital losses, which can to a reduction or elimination of capital gains tax payable.
Tax-loss selling is a simple strategy that does not require complex financial products or tax structure. It allows for a reduction in capital gains tax in the same tax year and, since it generates cash, provides flexibility to reinvest elsewhere.
Who can benefit from it?
Any investor with non-registered investments that have lost value can consider this strategy to reduce capital gains taxes.
How does this strategy work?
When investors realize a capital loss, they can first deduct it against the capital gains of the same year. If losses exceed realized gains, they can be deducted in the three previous tax years or carried forward indefinitely.
When is the best time to make a tax-loss sale?
The end of the tax year can be a good time to sell securities at a loss to offset the year's capital gains. That said, it remains important to monitor the investment portfolio throughout the year to identify loss-selling opportunities.
What are the key tax rules to consider?
Tax-loss selling is subject to specific rules for individuals, including:
- The Income Tax Act limits the amount of the loss realized and retained as a deductible capital loss for tax purposes to 50% (and to 66.67%, as of June 25, 2024, on the portion of net capital gains realized in the year that exceeds $250,000). This capital loss can potentially be used to reduce the calculation of taxable income. If no capital gains are realized in the current year, capital losses can be deducted in the three previous tax years or carried forward indefinitely.
- The Act also includes the “superficial loss" rule, also known as the "30-day rule." This rule prevents investors or their affiliates from deducting a capital loss realized on the sale of a security when the same security is repurchased within 30 days before or after its sale, for a total of 61 days including the settlement date. After this period, investors can repurchase the same securities without reversing the capital loss.
If the superficial loss rule is not respected, the capital loss will not be deductible.
How can ETFs be used?
It is possible to sell an ETF at a capital loss and reinvest the funds in ETFs of the same asset class or sector to maintain comparable exposure.
These transactions must meet certain criteria to not be considered identical to the initial investment sold at a loss. The expertise of an investment advisor is therefore essential for the new ETF to be considered “materially different” from your initial position, so the capital loss isn’t invalidated.
How to use this strategy to diversify a portfolio?
Selling at a loss can help rebalance the portfolio by liquidating underperforming investments and reinvesting in a more varied range of assets, thereby promoting better diversification.
Consult professionals
Since every tax situation is different, it is essential to consult a tax specialist and an investment advisor to assess the relevance of selling at a loss for tax purposes and to ensure compliance with the rules and deadlines.
For example, for a loss to be deductible in the current tax year, the advisor will ensure that the transaction is completed by the last trading day of the year. Typically, the settlement date occurs one business day after the sale.
Tax-loss selling can offer investors the opportunity to optimize their tax situation. By understanding how it works, they can turn capital losses into tax savings, while diversifying their portfolio.
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