December is harvest month for tax savings

How to claim a capital loss while keeping your investment strategy intact.

Matthew Elder 4 December, 2015 | 6:00PM

Markets have taken a beating in recent months and, while there's a chance some investments could recover in the near future, there's something to be said for selling a losing stock, bond or other capital investment now, regardless of its positive prospects.

By doing so you can use the resulting capital loss to offset capital gains realized during the same year or during one of the three preceding years -- and in the process recoup some of the tax you paid on those gains. You also can retain the loss to reduce capital gains realized in any future taxation year.

If the money-losing investment provides market exposure you no longer wish to have, the simplest solution is to sell it and replace it with something else. But if selling would throw off your asset-allocation strategy or disrupt a long-term investment plan, then you can sell it and replace it with something similar. The latter strategy is known as tax-loss harvesting.

What you can't do is sell that losing investment and realize the capital loss, and then immediately buy it back and expect to use that loss to offset capital gains realized from the sale of other investments. Doing so would trigger what the tax authorities call a superficial loss and thus make that loss ineligible to subtract from past or future gains.

However, there is nothing to stop you from immediately replacing the sold investment with a similar one. The following is a rundown on how capital losses can be used to reduce capital-gains tax, and how to use tax-loss harvesting to remain onside with the tax man with respect to the superficial-loss rule.

How to claim a capital loss

If you realize capital losses during a particular taxation year, you must first apply it against any capital gains realized that year to produce a lower net-capital-gain total, of which half is taxable. If your losses exceed your gains for that year, you can use the remaining portion to reduce gains realized during any of the past three years, or in any future year.

To do this, you subtract your allowable capital losses (that is, half of the actual amount lost) from your taxable capital gains (half of the actual profit). The amount of your allowable capital losses remaining from previous years is stated on your 2014 Notice of Assessment.

For example, if you sold several securities in 2015, producing profits totalling $10,000, the taxable amount of your gain would be $5,000. If you sold other securities for a total of $6,000 less than you paid for them, one-half of that loss, or $3,000, would be an allowable capital loss. Your net taxable capital gain for 2015 would therefore be reduced to $2,000 ($5,000 minus $3,000).

However, using this same example of a $5,000 taxable gain, let's assume that your allowable capital losses for 2015 were greater and totalled, say, $6,000 (or a total loss of $12,000). The allowable amount would more than offset your taxable capital gain for the year.

Consequently, you would report a net taxable gain of zero for 2015. In addition, this would leave a $1,000 unused amount of the allowable taxable loss. The unused amount would be available to reduce taxable capital gains reported on your 2012, 2013 or 2014 tax returns. Or, if you prefer, you could use the $1,000 unused amount to reduce taxable capital gains in any future year.

When using allowable capital losses from a past year to reduce your 2015 capital gains, you will have to base those amounts on the "inclusion rate" in effect when the loss was realized. Since 2001, that rate has been one-half (50%). However, this rate was higher between 1988 and 2000, as follows:

  • 1988 and 1989: two-thirds (66.66%)
  • 1990-1999: three-quarters (75%)
  • 2000: a specific rate stated on your 2000 Notice of Assessment

The 50% inclusion rate also was in effect before 1988.

What is a superficial loss?

To prevent taxpayers from purposely triggering a capital loss for tax-saving purposes without changing the content of their investment portfolio, a superficial-loss rule is in place. This prevents you or an "affiliated person" from selling an investment, realizing a capital loss, and then immediately buying back the identical investment. It requires you to not acquire the asset in question for 30 days before or after the original asset is sold at a capital loss.

If the 30-day period is not respected, the loss will be denied and added to the cost of the asset you purchased as a replacement. You cannot circumvent the superficial-loss rule by having an affiliated person -- such as your spouse or a corporation controlled by either of you -- repurchase that same asset.

It's worth noting that when you add the amount of the superficial loss to the adjusted cost base of the substituted property, the amount of your capital gain will be decreased -- or the capital loss increased -- when you eventually sell the substituted property.

In certain situations, when you dispose of capital property, the loss may not be considered a superficial loss, regardless of whether the identical investment is repurchased. For example, the superficial-loss rule normally does not apply in cases where the asset was sold because its holder died.

Nor will the rule apply if the holding was sold due to the expiry of an option, or because a corporation was wound up. As well, you normally will not face the superficial-loss rule in regard to transactions if you became or ceased to be a resident of Canada, or if you changed the property's use (such as in the case of real estate).

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Matthew Elder

Matthew Elder