Capitalizing on capital losses

If you or your spouse¹ have realized capital gains in the last three years, consider selling an investment that has dropped in value to recover the taxes paid on those gains.

Stock market volatility may cause investors to worry about their investments. Many want to take action and reorganize their portfolios, even if they’re in a loss position. Once the decision is made to crystallize losses, our capitalizing on capital losses strategy can be used to gain maximum tax benefit on portfolio losses. This strategy is based on carrying back any losses that exceed current year capital gains to a previous year with net capital gains.

The Income Tax Act (Canada) requires capital losses to first be applied against capital gains realized in the current year. If there’s any remaining balance, the net capital losses can be used to either reduce taxable capital gains in any of the three preceding years or in any future year.

The best strategy is to carry the losses back to the earliest year in which you have capital gains before it falls out of the three-year window. For example, the earliest date allowed to carry back 2021 losses is 2018.

If you don’t have capital gains this year or the previous three years but your spouse does, it’s possible to transfer capital losses to your spouse.

First, the investment is sold to crystallize the capital loss. Immediately afterwards, your spouse buys the exact same amount of the identical investment. Your spouse then sells the investment after waiting at least 31 days. The capital loss realized on your sale will be denied under the superficial loss rules and added to your spouse’s adjusted cost base instead, thereby transferring the capital loss.

Investors who:

• are selling their investments at a loss and who have little or no capital gains in the current year
• had capital gains, or their spouse had capital gains, in the past three years

To apply for a loss carryback, investors need to:

• complete form T1A, Request for Loss Carryback
• attach the completed form T1A to this year’s income tax return.

Canada Revenue Agency (CRA) will then automatically apply the losses to the previous years requested on the form.

Note

If you or your spouse repurchase property identical to that sold within the period that begins 30 days before and ends 30 days after the disposition, and still hold it on the 30th day after the disposition, then the capital loss on the original sale will be denied under the superficial loss rules. The denied loss is added to the adjusted cost base of the acquired property.

Tip

A trust version of a mutual fund isn’t identical to the corporate class version of the same mutual fund. Therefore, capital losses realized by the sale of a mutual fund trust won’t be denied under the superficial loss rules if the same fund is purchased in a mutual fund corporation, as you’re purchasing a different legal structure.

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1 Includes a spouse or common-law partner as defined by the Income Tax Act (Canada).