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Tax-loss selling: someone elseís loss could be your gain

by Wayne Cheveldayoff, 2003-12-08

Tax-loss selling occurs when investors want to trigger a loss in order to offset their capital gains and thereby avoid paying income tax.

Since this usually takes place as the year comes to an end, it also means that December is an ideal time to hunt for bargains in the Canadian stock market.

If youíve had your eye on a stock with the intention of buying if it got cheaper, this could be your opportunity to do so. A significant amount of trading activity during the month, especially for small-cap stocks, stems from Ďsell at whatever price you can getí activity by investors looking only at the tax benefit.

Any selling for tax purposes has to be done by December 24 in order to count for 2003 (since a trade takes three business days to settle and show up in the account).

After December 24, stocks that have been hit by tax-loss selling usually recover, although because of the lull in trading between Christmas and New Yearís Day, it may not happen right away.

The impact of tax-loss selling is often seen in price declines for small-company stocks with low trading volume. Large-cap stocks have institutional ownership and therefore much better trading liquidity.

A lot of small-cap stocks have rallied in 2003 but many are still well below where many investors bought them.

The outlook for the company is largely irrelevant. An investorís decision to sell a stock has more to do with his or her tax situation.

This year, investors may have real estate gains they may want to offset by selling stocks.

Capital losses cannot be claimed against ordinary income. They can only be deducted against capital gains.

According to the Canadian income tax rules, investors taking losses in 2003 can use them to offset capital gains incurred in 2003. If losses in 2003 exceed gains in 2003, the remaining losses can be applied to reduce capital gains in the three preceding years.

This means that investors can get a tax refund for any year going back to 2000 in which they have reported and paid income tax on capital gains. (Remaining losses can also be carried forward indefinitely).

As with many things related to income taxes, how you do it is important if you want to be sure to get the tax benefit. In the case of losses that are going to be used to offset gains, the stock being sold cannot be repurchased by you or someone related to you within 30 days. Your loss could also be denied if you bought more of the stock in the 30 days prior to selling it.

However, the rules donít prevent you from buying another stock or the same stock within a registered plan like an RRSP.

For investors looking to trigger capital losses, one thing to note is that if you own stocks of companies that have gone bankrupt or whose shares have declined to zero and are still owned by you, the rules allow you to attach a note to your tax return explaining the situation and reporting that the shares have been disposed of for no proceeds. You then claim the loss. (Of course, since you still own the stock, if a miracle gives it some value again and you eventually sell it, you would have to report a capital gain.)


Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at wcheveldayoff@yahoo.ca.


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©2003 Wayne Cheveldayoff