When it comes to investing, nobody wants to lose money. However, you can’t win on every single investment. Some positions simply don’t work out. But all is not lost. Enter tax-loss selling—a way you can turn a capital loss into a tax win.
The goal of tax-loss selling in taxable investment accounts is to realize capital losses before the end of the calendar year. With trades settling two business days after they’re made, trades for tax-loss selling purposes should take place no later than the third-last business day of the calendar year.
If capital gains were realized earlier in the same calendar year, they’re reduced by capital losses. If the realized capital losses equal the realized capital 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.
Before you sell, consider…
If your trading activity is considered a business, like a day trader, the gains or losses you realize wouldn’t be capital gains or capital losses. Instead, they would be business income or losses. In this context, business income or losses are fully included in or deducted from your taxable income. Otherwise, they’re capital gains or capital losses.
When selling foreign investments (i.e., stocks, bonds, mutual funds holding foreign securities), the capital gain or capital loss is reported in Canadian dollars for tax purposes. Generally, the currency is converted using the exchange rate in effect on the day of the transaction. Foreign exchange can impact the amount reported as a capital gain or capital loss. Converting from a foreign currency to Canadian dollars for tax purposes can increase or decrease the reported capital gain or capital loss. It can even turn a capital gain into a capital loss, or vice versa. Before selling foreign investments, be sure to incorporate the exchange rate in your calculations to confirm you’ll realize the capital gain or capital loss you’re expecting.
How do I carry capital losses back or forward?
To carry back capital losses, complete Form T1A, Request for Loss Carryback, and attach it to your current year’s T1 tax return. To apply net capital losses from other years to taxable capital gains in the current year, claim a deduction on line 25300 on the current year’s tax return.
Carrying back capital losses can be beneficial because you get the tax savings now. If you expect to be in the same tax bracket or a lower bracket in the future, carrying back capital losses may generate more tax savings. And since it’s a rolling three-year period, carrying back to the oldest year first makes sure you don’t miss that year’s tax savings.
If you expect to be in a higher future tax bracket, you may want to carry capital losses forward, especially if you’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 else should I be aware of with capital losses?
The superficial loss rules—if a capital loss is deemed superficial, it can’t be used to offset realized capital gains. Instead, the capital loss is added to the adjusted cost base (ACB) of the identical property. For a capital loss not to be deemed superficial, you or an affiliated person must:
- not buy an identical property for 30 calendar days before or 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 you or your spouse, corporations and partnerships controlled by you or your spouse, and trusts where you or your spouse are a majority beneficiary. Such trusts can include a registered retirement savings plan (RRSP), registered retirement income fund (RRIF), tax-free savings account (TFSA), or registered education savings plan (RESP) where you or your spouse is a subscriber.
An identical property can be the exact same security or one that’s the same as the one you sold in all material respects; for instance, an exchange-traded fund (ETF) that tracks the same index, even if it’s from another fund company.
Superficial losses aren’t all bad. In fact, when it comes to spouses, they can be a very good thing under the right circumstances. To learn more about how spouses can make superficial losses work for them, see “Capitalizing on capital losses.”
Applying net capital losses from other years to this year or carrying capital losses back to previous years won’t affect the amounts you’re eligible for from income-tested benefits. The reason is that, on your tax return, 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.
Line 23400 is used to calculate amounts such as the Old Age Security (OAS) clawback or employment insurance repayment. Line 23600 is used to calculate federal and provincial non-refundable tax credits. This includes the Canada child benefit (CCB), 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 won’t reduce clawbacks to benefits like OAS or increase amounts received from benefits like the CCB.
Capital losses and corporations
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 federal 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 federal 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, you should consider reviewing the current capital dividend account (CDA) balance with your tax advisor. If there’s a positive balance, 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.
Short-term savings vs long-term investment goals
Tax-loss selling is a way of taking capital losses and turning them into a tax-savings win. Finding capital losses in your taxable portfolio may be easier in volatile markets than in strong bull markets. Be sure to balance a short-term tax savings decision with your long-term portfolio objectives.
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