After a tough loss, a coach or player may talk about a moral victory as they try to turn a negative outcome into a win. The tax and investing equivalent is tax-loss selling: realizing capital losses and using them to “win” some tax savings.
The goal of tax-loss selling in taxable investment accounts is to realize capital losses before the end of the calendar year. If capital gains were realized earlier in the same calendar year, they are reduced by the capital losses. If the realized losses equal the realized gains, the investor has no capital gains tax to pay. And if the current year’s capital losses are greater than the capital gains, they can be carried back up to three years to offset capital gains or carried forward indefinitely to offset future capital gains.
How do I carry capital losses back or forward?
For the 2022 tax year, the three carry-back years for capital losses will be 2019, 2020 or 2021. To carry back capital losses, complete Form T1A, Request for Loss Carryback and attach it to the 2022 tax return. To apply net capital losses from other years to taxable capital gains in 2022, claim a deduction on line 25300.
Carrying back capital losses can be beneficial because the client benefits from tax savings now. If the client expects to be in the same tax bracket or a lower bracket in the future, carrying back capital losses may generate more tax savings. Further, since it’s a rolling three-year period, carrying back to the oldest year first ensures the client doesn’t miss that year’s tax savings.
However, a client who expects to be in a higher future tax bracket may want to carry capital losses forward, especially if they’re planning to sell securities that are likely to have a realized capital gain. While that sacrifices the certainty that comes from carrying capital losses back, the expected tax savings in the future may be worth the risk.
What’s the catch?
The superficial loss rules. If a capital loss is deemed superficial, it can’t be used to offset realized capital gains. Instead, the loss is added to the adjusted cost base (ACB) of the identical property. For a capital loss not to be deemed superficial, the client or an affiliated person must:
- not buy an identical property for 30 calendar days before and after the settlement date of the sale, and;
- not continue to own the identical property 30 calendar days after the settlement date of the sale (61 days total including the settlement date).
An affiliated person includes the client or their spouse, corporations and partnerships controlled by the client or their spouse, and trusts where the client or their spouse are a majority beneficiary. Such trusts can include a RRSP, RRIF, TFSA and RESP where the client or their spouse is a subscriber.
An identical property can be the exact same security or one that is the same as the one the client sold in all material respects; for instance, an ETF that tracks the same index, even if it is from another manufacturer.
Applying net capital losses from other years to this year or carrying losses back to previous years won’t affect the amounts the client is eligible for from income-tested benefits. The reason is that net capital losses of other years (line 25300) are deducted after net income before adjustments (line 23400) and net income (line 23600). However, current year capital losses will reduce or eliminate the taxable capital gains reported on line 12700, and this will reduce amounts reported on lines 23400 and 23600, helping preserve the related benefit amounts.
Net income before adjustments is used to calculate amounts such as the old age security clawback, employment insurance repayment and the Canada recovery benefits repayment. Net income is used to calculate federal and provincial non-refundable tax credits. This includes the Canada child benefit, the GST/HST credit and the age amount, among other credits.
In other words, using net capital losses from other years to reduce net capital gains will not reduce clawbacks to benefits like OAS or increase amounts received from benefits like the Canada child benefit.
Similarly, for corporations with income from passive investments that are looking to decrease their adjusted aggregate investment income (AAII), the current year’s capital losses will reduce the taxable capital gains included in this calculation. However, capital losses from other years will not. This is important because passive income earned inside a corporation can lower a corporation’s small business deduction (SBD). This reduction begins when a corporation (or a group of associated corporations) earns $50,000 of passive income in a year. The SBD will be fully eliminated when passive income reaches $150,000. For each dollar of passive income over $50,000, the SBD will be reduced by $5.
Before realizing capital losses within a corporation, clients should consider reviewing the current capital dividend account (CDA) balance. If there is a positive balance, they could consider paying a tax-free capital dividend to shareholders before realizing the capital losses. Otherwise, half the realized capital loss will reduce the positive CDA balance and reduce the amount of tax-free money that can be paid to shareholders now.
If realizing capital losses creates a negative CDA balance, a tax-free capital dividend can’t be paid until that balance is positive, like when future capital gains are realized.
What about cryptocurrencies?
It’s been a tough year for cryptocurrencies and clients may find themselves with unrealized losses in their crypto portfolios. However, the rules aren’t straightforward when it comes to cryptoassets.
Where a taxpayer’s transactions in cryptocurrencies are on account of capital, the gains or losses from such transactions are capital gains or losses. In such circumstances, realized capital losses from cryptocurrency trades can be used to offset realized capital gains from the sales of securities like stocks, ETFs, mutual funds or segregated fund contracts.
This differs from transactions on income account — which are as seen as carrying on a business — or barter transactions, which are used to purchase goods and services. Income account transactions are fully taxable income, while the tax implications for barter transactions are the same as if the transaction was completed with normal currency.
Tax-loss selling is a way of taking losses and turning them into a tax-savings win. Finding losses in your taxable portfolio may be easier in volatile markets than in strong bull markets. Be sure to help clients balance a short-term tax savings decision with their long-term portfolio objectives.
Curtis Davis, FCSI, CFP, TEP, is director for tax, retirement and estate planning services, retail markets at Manulife Investment Management