Tax Loss Selling: What you need to know

07 November 2022 by National Bank Direct Brokerage
Man calculating the fiscal impact of their investment

Whichever investing strategy an investor follows, their goal is to grow their portfolio. With a non-registered account there will be tax implications regarding any gains. Learn how an investor with capital gains can save on their taxes by applying a tax-loss selling strategy.

What is tax-loss selling?

Tax-loss selling, also known as tax-loss harvesting, is a tax strategy designed to minimize or cancel out capital gains. The investor will sell securities (e.g., stocks, ETFs, mutual funds) held in their non-registered accounts that have decreased in value below the book value to create a capital loss, which can then be used to offset other capital gains.  

How it works and why?

The idea behind this strategy is to decrease or offset one’s taxable capital gains by selling investments in a non-registered account that are at a loss. The goal is to time them so that the loss occurs in the same fiscal year as the gain. This would minimize the amount of tax payable on the 50% of the capital gain that is taxable or eliminate the tax owing altogether.  

Example of tax-loss selling 

An investor sells shares of ABC stock in their cash account this year and has realized a capital gain of $5,000 that will need to be declared on their tax return. The investor also holds shares of XYZ stock whose share price has declined, which if sold during the same year would result in a capital loss of $5,000. The investor does not expect the shares of XYZ to recover in the near term and proceeds to sell them. The result is that the net capital gain is zero and no tax is owing. 

When does tax-loss selling start 

Most conversations about tax loss selling usually tend to occur in the month of December, as investors take stock of their trading wins and losses. Investors have until two business days before the last trading day of the year to sell their shares and crystallize the loss. 

Ideally tax loss selling should be a year-round consideration for the investor. By waiting till the last minute there might not be any securities to select for a capital loss or the market sentiment might have changed to positive on the potential securities and the investor would prefer to hold onto them. If the shares are sold and have been bought within a time frame of 30 days before or after, the superficial tax loss rule would take effect. 

What’s the superficial tax-loss rule? 

For most investors, tax loss selling is straightforward. But there are certain rules that the Canada Revenue Agency (CRA) has in place that need to be followed.  

When an investor sells a security to realize a loss, the superficial loss rule states that the capital loss will be denied if the investor purchases an identical security within 30 calendar days of the settlement date of the sale. This also means you can't purchase the security 30 days before your settlement date as well. An investor can’t sidestep this rule by making the purchase via another account like a RRSP or an affiliate such as a corporate account or even a spouse’s account. 

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Good to know! The settlement date of a securities’ sale is 2 business days after the date you sold or bought a security. You can find it on your account history or trade confirmation in your brokerage account.

Considering the 30-day rule

One of the recurring questions that investors have about tax loss selling concerns the 30-day rule. What can be done if they believe that the stock selected for capital loss might increase in value shortly? The investor’s dilemma is wanting their stock to increase but also wanting their capital loss to balance their gain. The superficial tax loss rule is clear: investors can’t purchase the same stock or a call option on the same security during those 30 days.  

A possible solution is to purchase a non-identical security that has also decreased in value, perhaps a competitor’s shares that have also dropped. Another alternative is to purchase an ETF in the same industry or sector. The only rule must be that it is not an identical property to avoid the superficial loss rules.  

Things I need to know about tax loss selling 

When a security is sold for tax loss purposes, it can be used to offset capital gains during the current fiscal year but also going back the three previous years. The investor can also hold onto their capital loss to be used in the future; it doesn’t expire. An accountant can help investors navigate this strategy.  

Considering the impact of the currency on capital gains

Using the tax loss selling strategy with US securities, it’s important to consider the currency fluctuations as well. The loss could be lower than expected—or even be nonexistent—if the US currency has appreciated versus the Canadian dollar. A holding can have a capital gain in a foreign currency but have a loss in Canadian dollars. 

Obviously, every investor’s individual circumstances may vary, consulting with a tax professional before planning or enacting a tax-loss strategy could be required. 

Making good use of a capital loss

Human nature has hardwired us not to like taking a loss but even the most successful investors, on occasion, will have securities that drop in value. Tax-loss selling allows the investor to make good use of this loss. 

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Key takeaways
 

  • Tax-loss selling, also known as tax-loss harvesting, is a tax strategy designed to minimize or cancel out capital gains. 

  • The idea behind this strategy is to decrease or offset one’s capital gains by selling investments in a non-registered account that are at a loss. 

  • Investors have until two business days before the last trading day of the year to sell their shares and crystallize the loss. 

  • The superficial loss rule states that the capital loss will be denied if the investor purchases an identical security within 30 calendar days of the settlement date of the sale.  

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Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus of the BMO ETFs before investing. Exchange traded funds are not guaranteed, their values change frequently, and past performance may not be repeated.

For a summary of the risks of an investment in the BMO ETFs, please see the specific risks set out in the BMO ETF’s prospectus. BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.

BMO ETFs are managed by BMO Asset Management Inc., which is an investment fund manager and a portfolio manager, and a separate legal entity from Bank of Montreal.

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