The last days of the year are approaching and with them, the last chance to harvest capital losses for tax purposes.
The practice known as tax-loss selling involves selling investments in a loss position to offset the capital gains realized by other investments. While this practice has no effect in tax-sheltered accounts such as RRSPs and TFSAs, in a non-registered account, tax-loss selling allows a client to reduce their capital gains tax liability.
Net capital losses can be carried back three years or carried forward indefinitely to offset net capital gains in other years. Sales of securities must settle within the calendar year in order to offset capital gains realized in the same year (or previous three years).
The last day to tax-loss sell Canadian-listed stocks is Dec. 29. Trades executed on Dec. 30 and 31 will settle on Jan. 4 and 5, 2021, respectively — making them ineligible for tax-loss harvesting in 2020. (On another note, Dec. 31 is the last day to make a donation to registered charity that can be claimed in the 2020 tax year.)
Clients who tax-loss sell may be tempted to repurchase the same securities at a later date. To avoid running afoul of the superficial loss rules in the Income Tax Act, clients should wait at least 30 days after the sale to repurchase the security. The same goes for anyone considered an “affiliated person” to the client.
Clients would also violate the superficial loss rules if they bought the same securities during the period beginning 30 calendar days before the sale.
The definition of the “same securities” — known officially as “identical property” — is broader than one might expect. The Canada Revenue Agency considers different series of the same mutual fund to be identical property. ETFs that track the same index (e.g., the S&P/TSX composite), even if they are manufactured by different financial institutions, are also considered identical property.
Another way to sidestep the superficial loss rules is to look for what Justin Bender and Dan Bortolotti, portfolio managers at PWL Capital Inc., have called “ETF pairs” — two ETFs that can be used interchangeably from a risk and asset class perspective, but that each track different indexes. Bender and Bortolotti have written a whitepaper about the practice.