As an advisor, you want to make sure your client seizes tax-planning opportunities. For non-registered accounts, that includes tax-loss harvesting, where accrued losses on investments are realized to offset capital gains.
While tax-loss harvesting presents an opportunity to add value, “we can’t let the tax-tail wag the investment-dog,” says Rebecca Hett, vice-president of tax, retirement and estate planning at CI Investments in Calgary. The strategy must make sense as part of the client’s overall portfolio, she says.
Likewise, Darren Coleman, senior vice-president and portfolio manager at Coleman Wealth, Raymond James in Toronto, says the investment thesis comes first. Most of his clients are in model portfolios, so he generally captures tax-loss harvesting in conjunction with model rebalancing, performed in June and December.
“We don’t sell just because we think we should from a tax perspective,” he says. “We look to see where we are going to upgrade the portfolio.” For example, when rebalancing this year, certain Canadian banks might present a buying opportunity, he says.
For Paul Wylie, vice-president of business development at IPC Private Wealth in Toronto, investment goals remain front and centre, but tax is an ever-present reality that must be managed, he says. His firm performs tax-loss harvesting regularly as a service to discretionary clients. Volatility can occur throughout the year, so “we want to capitalize on those opportunities [to] crystallize some losses, which we can carry forward and offset against tax,” he says. “Because we can create that value throughout the year, we don’t have to hit homeruns” when it comes to returns.
Further, with regular tax-loss harvesting, he says, the firm avoids potential market impact when investors sell en masse in the last couple months of the year. At that time, the firm looks for opportunities to add to positions, he says.
The firm also considers tax-loss harvesting on an individual client basis, based on client discovery or annual reviews. For example, clients could have accounts at other firms to consider, says Wylie. Coleman notes that clients who transfer funds sometimes have worthless securities and should be informed that they can claim a capital loss—something they might not know and can discuss with their tax professionals.
Wylie says his firm wouldn’t perform tax-loss harvesting when, for example, the proxy index used for temporary sector exposure is down more than the holding in question—a situation that occurred about a year ago within oil and gas. While some clients suggested holding cash instead of the proxy index, the firm’s strategy is to continuously participate in the market—something that is explained and accepted by most clients, he says. Because the firm performs tax-loss harvesting regularly, forgoing the strategy that one time wasn’t a big deal, he says.
During times of distributions—typically mid-November for fund companies—the firm avoids investing clients’ new money in taxable accounts. Instead, the funds might be invested in a proxy index with no distributions as a way to “sidestep the obvious tax” when the client hasn’t been holding the fund for the entire year, says Wylie.
In addition to distributions, Coleman notes that hedge or alternative funds can have performance fees near year-end, which is another reason to hold off on investing new money. He suggests consulting fund companies to find out when they plan to make distributions.
Performing tax-loss harvesting is one thing; communicating its value is another.
Coleman says he explains to clients why he performs tax-loss harvesting and how it’s been accomplished in a year. “You need the client to know you’re doing it so they can attribute value to it,” especially as an advisor who charges fees, he says.
In advance of tax-loss harvesting, he explains the strategy to clients; tax reports are also prepared and discussed with clients during spring reviews so they can see what was sold, how tax was offset, and also what was bought. “We didn’t just do a tax manoeuvre. We also show them how we upgraded the quality of the portfolio,” he says. “The magic is showing them both of those things.”
Wylie’s firm began quantifying tax-loss harvesting a few years ago, which likely increased the popularity of the service among clients, he says. For balanced portfolios, the value-add is about 50 to 55 basis points on average.
Tax-loss harvesting might also contribute to business growth for advisors, says Wylie. As advisors prepare gain/loss summaries at year-end and reach out to clients’ tax professionals, that contact potentially helps them gain clients through referrals—particularly when advisors demonstrate care by having accurate cost base figures, he says. (When clients transfer funds to the firm, the firm is careful to document accurate cost base information, he adds.)
Hett says tax-loss selling is most effective “when the investment advisor and the accountant are directly communicating,” instead of going through the client. That way, the tax professional can better understand a portfolio’s investment strategy leading into the last quarter, and the advisor can better understand a client’s tax position to make ideal investment decisions.
Where there is a net capital loss for the year, it can be carried back three years or carried forward indefinitely. Thus, Hett says advisors should ask tax professionals about a client’s prior three notices of assessment from CRA to ascertain if there are previous net capital gains (line 127) to offset. Alternatively, net capital losses from other years (line 253) might be applied against taxable capital gains in a current year.
In addition to tax-efficient planning, good communication between tax pros and advisors might save time and subsequently help clients save on accounting fees, says Hett. She adds that client consent is required to open up the channel of communication between advisors and tax professionals.
Also read: Golombek’s year-end tax tips for clients