The leaves are still on the trees in many parts of the country, but that shouldn’t stop investors from thinking about the year-end deadline for tax-loss selling.
Tax-loss selling brings an opportunity to use 2023 stock market losses to recoup tax paid on capital gains in the past three years, or reduce tax on capital gains any year in the future.
Because half of capital gains on equities sold in a non-registered trading account are taxed, half of capital losses can eliminate the taxes on capital gains dollar-for-dollar.
As an example; if you accumulated $10,000 in capital gains on equities sold last year and claimed the required $5,000 as income, $10,000 in capital losses will get you a full refund.
WHY AN EARLY STRATEGY IS IMPORTANT
Tax-loss selling is pretty straightforward from a tax perspective but it can get complicated from an investment perspective. The last thing you want to do is sell a good stock that is in a short-term slump to save a few tax dollars.
A qualified advisor can help isolate the sleeping giants from the dogs, and you still have several weeks to track their performance. With the third quarter behind us, there is one last chance to evaluate a company’s most current financial health as we head into earnings reporting season.
If the investment you want to dump is an equity mutual fund or exchange traded fund (ETF), be careful not to throw the baby out with the bathwater. In other words, don’t sell a good portfolio if a few laggards are dragging it down.
Timing is also an important consideration for tax-loss selling. With the TSX Composite Index at about break-even for 2023 so far, and a decline of eight per cent in 2022, there are probably plenty of losers to choose from this year.
But you might need to go back to 2021, when the TSX advanced by 22 per cent, to find winners that have been taxed. Tax paid on capital gains can only be recouped by capital losses going back three years, which means your options could be limited if you wait until 2024.
BEWARE OF THE SUPERFICIAL LOSS RULE
As with any tax strategy, the Canada Revenue Agency (CRA) has strict rules when it comes to tax-loss selling.
The most important is called the superficial loss rule, which prohibits the repurchase of the same stock within thirty days of the tax loss sale. The superficial loss rule applies to repurchases in any registered or non registered account in the name of the account holder, and even the account holder’s spouse. If you want to repurchase the same stock you must wait at least 31 days from the sale.
USING A TFSA AND RRSP FOR MORE TAX SAVINGS
It’s important to note that tax-loss selling, or tax on capital gains does not apply to investments in registered accounts including a registered retirement saving plan (RRSP) or a tax free savings account (TFSA).
The tax savings from tax-loss selling, however, can generate further tax savings by shifting the proceeds from a non-registered account to registered accounts.
While half of capital gains are taxed in a non-registered account, the tax on capital gains in a TFSA is zero. Capital gains in a RRSP are fully taxed when withdrawn in retirement along with income and original contributions, but investors are permitted to deduct their contributions from their taxable income.
RRSP contributions made before the March 2024 deadline can be deducted from 2023 income or carried forward to future years when your tax burden is heavier.
With both the RRSP and TFSA, capital losses don’t apply from a tax perspective because capital gains are never directly taxed in the first place.
There are other specific rules set out by the CRA for tax loss selling and contributing to registered accounts which must be followed, so consider speaking with a tax professional.