The primary reason for selling an investment should be that you no longer feel it is the best opportunity available.
But you can do last minute tax loss selling is to reduce tax or to recover past tax paid. As year-end approaches, we encourage you to take an assessment of your tax situation. .
Rather than waiting until March, you may want to do some rough calculations now while you still have some control over your 2007 taxable income.
Start by gathering the following pieces of tax information:
- Unused net capital loss carry forward information by year
- Net capital gain information for 2004, 2005 and 2006
- Realized capital gains or losses for 2007 from selling non-registered investments (not including RRSP, RRIF, RESP), including stocks, bonds, mutual funds, exchange traded funds and real estate
- Listing of unrealized capital gains and losses on your non-registered investments (those that you still own and have not yet sold) by taking the difference between the current market value and the adjusted cost base.
The following is a quick list of items to factor in when looking at your 2007 tax situation and non-registered investments:
- Mutual fund distributions or other income distributions designated as capital gains are generally included on tax slips (T3 and T5) that arrive in early 2008
- Certain mutual fund and exchange traded fund distributions increase the adjusted cost base
- Dividend reinvestment plans should be factored in when determining an average cost for tax purposes
- If you hold the same security in multiple non-registered accounts you will have to calculate an average cost for tax purposes
- Some investments have a return-of-capital component which reduces the original cost that you paid
- Bonds purchased at a premium will create a capital loss at maturity and bonds purchased at a discount will create a capital gain
- Investments denominated in a foreign currency should have a cost base that is converted to Canadian dollars
- If you have any defunct or de-listed securities you should determine if you have previously claimed the capital loss
- Ensure you factor in any February 24, 1994 elections that you made
The following outlines some general rules to adhere to before doing any tax loss selling:
- Do not break the superficial loss rules. If you are selling a security to realize a capital loss then you or an affiliated person (i.e. spouse, corporation) must not purchase the identical security within 30 calendar days.
- Do not transfer positions that are in a loss position to your RRSP as an “in-kind” contribution.
- Any donation of securities in-kind should be those that have unrealized capital gains only.
- Carry all current net capital losses back to the earliest year in which you have capital gains (maximum three years back).
- Focus on quality investments rather than making decisions solely for tax purposes.
The following are a few strategies relating to tax loss selling:
Strategy 1: Tax-loss selling and RRSP season often provide some opportunities for investors with cash on the sidelines. Positions that have performed negatively during the year may incur additional pressure as people execute on tax-loss selling. Obtaining a list of the year’s worst performing stocks may create some attractive entry points. Some of the worst performing companies in 2007 may have positive outlooks for next year.
Strategy 2: You can give shares that are in a capital loss position to your children. You then can claim the appropriate tax loss. If the investment increases in value in the future then the capital gain would be taxable to the child. If the child has no other income then the gain should be tax-free if the taxable portion of the capital gain is under the basic exemption.
Strategy 3: Transferring capital losses to your spouse (or common law partner) may assist you in maximizing the tax refund. This strategy should be followed if your spouse is in a higher marginal tax bracket than you or, has net capital gains from the past three years. In order for your spouse to be able to claim your capital loss you will need to sell your spouse your shares at today’s market value. Because of the superficial loss rules, your loss will be denied for tax purposes. However, your loss will be added to your spouse’s cost base. As a result, you have effectively transferred your loss to your spouse. Your spouse must hold the shares for 30 days prior to selling the shares in the open market in order for their loss not to be denied for tax purposes.
Strategy 4: Sell positions that have a capital loss earlier in the year and wait 30 days. After 30 days you may purchase the investment again. For this strategy to work you need to factor in transaction costs, if any, and have the belief that the investment will not increase during the 30 day waiting period.
Most security transactions take three business days to settle after the trade is entered. This year the last day for tax loss selling in Canada is December 24, 2007 and in the United States it is December 26, 2007.
This column highlights some of the “tax” items to consider prior to “tax loss selling.” If you have significant capital gains or losses, we encourage you to meet with your financial advisor and accountant.