With 2017 turning out to be a banner year for many clients’ portfolios as markets hit all-time highs, it seems odd to focus my last column of 2017 on tax-loss selling.
Yet, in a year in which investors may have realized significant capital gains by taking profits and/or portfolio rebalancing, what better time to crystalize any losers in the portfolio and use those losses to offset taxes owing next spring on gains realized earlier in 2017?
What is tax-loss selling?
Tax-loss selling involves selling investments with accrued losses at year-end to offset capital gains realized elsewhere in your portfolio. Any net capital losses that cannot be used currently may either be carried back three years or carried forward indefinitely to offset net capital gains in other years.
In order for a loss to be immediately available for 2017 (or one of the prior three years), the settlement must take place this year. Canada has adopted a shorter settlement period in 2017 for equity and long-term debt market trades, so as to coincide with a change to a T+2 standard in American markets. This means that, rather than the previous three business-day settlement period, trades are now settled in two business days, effective Sept. 5, 2017. To complete settlement by Dec. 31, the trade date must be no later than Dec. 27, 2017.
As in prior years, be mindful of the superficial loss rules that apply when you sell property for a loss and buy (or have bought) identical property in the 30 days before or after the sale date. The rules apply if property is repurchased within 30 days and is still held on the 30th day by you or an “affiliated person,” including a spouse (or partner), a corporation controlled by you or your spouse (or partner), or a trust for which you or your spouse (or partner) are a majority beneficiary (such as your RRSP or TFSA). Under the rules, the 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 could only be obtained when the repurchased security is ultimately sold.
Foreign currency transactions
It’s especially important to consider the effects of foreign currency fluctuations if your client has purchased securities in a foreign currency, since 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 assume your client, Isaac, bought 1,000 shares of a U.S. company in November 2012 when the price was US$10 per share and the U.S. dollar was at par with the Canadian dollar. Today, the price of the shares has fallen to US$9 and Isaac decides to do some tax-loss harvesting. He calculates that he has accrued a capital loss worth US$1,000: (US$10 minus US$9) × 1,000. He wants to apply that accrued capital loss against gains he realized earlier this year.
Before knowing if this strategy will work, Isaac will need to convert the potential U.S. dollar proceeds back into Canadian dollars. At an exchange rate of US$1 = CA$1.25, selling the U.S. shares for US$9,000 yields CA$11,250. What initially appeared to be an accrued capital loss of US$1,000 (US$10,000 less US$9,000) turns out to be a capital gain of $1,250 ($11,250 less $10,000) for Canadian tax purposes. If Isaac had gone ahead and sold the U.S. stock, he would actually be doing the opposite of tax-loss selling and accelerating his tax bill by crystallizing the accrued capital gain in 2017.