Tax-loss harvesting with ETFs can lighten tax burdens
When markets are volatile and aren’t offering much opportunity to make money, it’s a good time to enact a tax loss selling strategy using ETFs to lighten your clients’ tax burden.
The concept behind this strategy, tax-loss harvesting, is simple: an investor deliberately sells securities at a loss in order to realize capital losses. Net capital losses are calculated exactly the same way as net capital gains. Fifty percent of the net capital loss is eligible to be used as a potential deduction when filing a personal tax return.
Many investors are hesitant to sell securities at a loss because tax-loss-selling rules prevent them from reinvesting in the same security for at least 30 days from when it’s sold, potentially resulting in missed upside opportunity.
But investors aren’t entirely helpless during a loss period. ETFs allow them to capitalize on their market losses and reduce their past, present and future taxable income (see sidebar, “CRA rules”). Returning some money to clients during a period of negative market returns can be powerful consolation.
Sell the stock, buy the index
ETFs can be used to maintain broad market or sector exposure while harvesting tax losses from individual equity positions.
Index-tracking ETFs typically offer a high degree of equivalent market beta to mutual funds or stocks. An investor could sell any of those securities at a capital loss for tax purposes, if applicable, to offset capital gains from the previous three years, or apply to current or future gains.
An investor could then purchase an ETF that invests in the same or similar asset class—or even the same index with a similar risk/ return profile and correlation to the original security.That way, he or she can harness capital losses to reduce taxable income while maintaining market exposure when prices are anticipated to rise.
Here’s how it works.
Almost every equity strategy, whether it involves stocks or mutual funds, probably has a comparable ETF alternative listed on the TSX that can give an investor similar market exposure, or beta, as the original security.
Keep in mind the last day for tax-loss selling for Canadian-listed stocks is three days before the last business day of the year (so December 26, 2012 this year). Of course, this strategy can be used throughout the year to harvest losses.
Big losers of 2011
National Bank Financial’s Product Research Group released a report highlighting a number of large-cap Canadian stocks that suffered significant losses in 2011. The table includes potential ETF replacements and their stock-related correlations. Advisors can implement a tax-loss-harvesting strategy for clients if they have significant holdings in any of these stocks.
Tax loss strategy as of 28-nov-2011
|ETF Name||Ticker||Stock Weight
|Teck Resources Ltd||TCK/B||-44.9%||iShares S&P/TSX Global Base Metals Index Fund||XBM||9.3%||77.1%|
|Pan American Silver Corp||PAA||39.0%||Horizons Enhanced Income Gold Producers ETF||HEP||6.4%||78.5%|
|Kinross Gold Corp||K||28.4%||Horizons Enhanced Income Gold Producers ETF||HEP||6.2%||74.3%|
|Consumer||George Weston Ltd||WN||-22.8%||iShares S&P/TSX Capped Consumer Staples Index||XST||7.9%||32.6%|
|Energy||Niko Resources Ltd||NKO||-53.2%||Horizons GMP Junior Oil and Gas Index ETF||HJE||6.7%||38.9%|
|Talisman Energy Inc||TLM||41.2%||Horizons Enhanced Income Energy ETF||HEE||6.5%||81.3%|
|Pacific Rubiales Energy Corp||PRE||39.4%||Horizons Enhanced Income Energy ETF||HEE||6.3%||69.7%|
|Financial||Sun Life Financial Inc||SLF||-38.7%||Horizons Enhanced Income Financials ETF||HEF||8.3%||78.9%|
|Manulife Financial Corp||MFC||-36.4%||Horizons Enhanced Income Financials ETF||HEF||8.6%||84.9%|
|AGF Management Ltd.||AGF/B||-22.9%||Claymore S&P/TSX Canadian Dividend ETF||CDZ||5.2%||62.4%|
|Industrial||Celestica Inc||CLS||-14.7%||iShares S&P/TSX Capped Info. Tech. Index Fund||XIT||11.8%||66.2%|
|Technology||Wi-Lan Inc||WIN||-12.7%||iShares S&P/TSX Capped Info. Tech. Index Fund||XIT||5.2%||47.3%|
|Utilities||Just Energy Group Inc||JE||-33.5%||BMO Covered Call Utilities ETF||ZWU||5.5%||40.4%|
|Atlantic Power Corp||ATP||10.5%||BMO Equal Weight Utilities Index ETF||ZUT||6.4%||45.5%|
*Correlation 2011 YTD or since ETF inception; Sorted by sector alphabetically, then by YTD Price Return
Source: National Bank Financial, Bloomberg, Horizons, BMO, Claymore, iShares
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Originally published in Advisor's Edge Report
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