As the leaves turn and pumpkin flavour becomes ubiquitous, thoughts turn to the fall season and harvesting. As it turns out, investors may wish to do some harvesting in their investment portfolios in order to generate tax savings.
Specifically, tax-loss harvesting, or tax-loss selling, is a strategy that is used to reduce the tax paid on capital gains by triggering capital losses from non-registered investments and offsetting those losses against the gains.
Capital losses are first applied against gains that arise in the same year, but excess losses can either be carried back three years or carried forward to a future year. If you’ve experienced a large gain the past couple of years, perhaps due to an investment property sale or rebalancing of a portfolio, it may be prudent to strategically review your portfolio to trigger losses that can specifically offset those large gains.
Investors often behave irrationally when it comes to holding on to “losing” stocks, waiting inordinately long times for the stock to recover before selling. However, it is often more prudent to consider the current dollar value of the investment and ask oneself what is the best use of that sum of money? If the outlook for the investment is not strong or the timeframe for recovery is too long, selling it may be a better option than holding out for the recovery. Not only will you be able to redeploy the funds to an investment with a better outlook, you can also improve your after-tax returns by using the loss to offset gains. If those gains arose in a prior year, carrying back the losses will generate a tax refund of taxes paid in that prior year.
In other cases, an investment may have dropped in value, but you expect that decline to be temporary. You may still choose to sell the investment in order to crystallize the loss and take advantage of the tax savings, but, long-term, you ultimately want to hold the investment. If you decide to sell the investment and reacquire it, there are important rules of which to be aware so that the loss is not denied as a “superficial loss” – most commonly if you acquire or reacquire an identical investment in the 30 days before or after the date of sale.
If you have concerns about missing out on potential sector or market returns during the “superficial loss” period, you may purchase a sector or index ETF to hold in the interim. It is only purchases or re-purchases of the “same” investments that are disallowed. It is not just shares of the same class but investments that are the same in all material aspects that are considered identical property. Therefore, it is prudent to seek advice on what may be considered “identical property.” For instance, an ETF version of a mutual fund issued by the same investment management firm could be considered the same investment or investments.
While in many instances there is a broad definition of “disposition” to include transfers of investments to registered plans, when it comes to triggering capital losses to offset capital gains, only a true sale of the investment will have the desired outcome. A transfer of shares or investments into your RRSP or TFSA will deem the capital loss to be nil and will not be available to offset capital gains.
Any tools that can be used to reduce the household tax bill allows for reinvestment of the tax savings that will further compound over time and ultimately build more wealth. As a Chartered Accountant turned wealth manager, I use such tax reduction strategies wrapped around investment advice to help our clients achieve their vision for prosperity
No matter the financial question you are grappling with, reach out to your wealth advisor for advice – true wealth accumulation is about more than investment selection.
If you have questions about wealth management strategies, you can reach me at Joelle.Hall@RichardsonWealth.com
This article is supplied by Joelle Hall of Hall O’Brien Wealth Counsel, Director, Wealth Management, Portfolio Manager, and Investment Advisor with Richardson Wealth Limited.
Hall O’Brien Wealth Counsel specialize in tax-efficient portfolios and planning. We speak your language, so you feel confident in the plan we implement together.
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