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Tax-loss selling turns an investment loss into a tax gain

by Wayne Cheveldayoff, 2006-11-09


Selling your losing investments is an important tax-planning tactic that can turn your investment loss into a tax gain.

If you get it done well before the late-December deadline, youíll probably get a better price for your loser. Many investors leave it to the last minute and end up selling when everyone else is.

Tax-loss selling occurs when investors want to trigger a loss to offset their capital gains and thereby avoid paying as much income tax as they otherwise would.

This only applies to non-registered accounts (meaning it doesnít apply to securities you hold in your RRSP, RRIF or RESP).

The underlying tax rules allow individuals to deduct their capital losses against capital gains (but not other income).

A capital loss incurred in 2006 can be used to offset capital gains incurred in 2006 or, if there arenít enough gains to use up all the losses this year, in any of the last three years.

This means investors can save on income taxes for this year, or get a tax refund for any year going back to 2003 in which they have reported and paid income tax on capital gains.

Furthermore, the remaining capital losses can be carried forward to offset capital gains in future years.

December 22 (Friday) is the deadline for tax-loss selling for stocks traded on the Toronto Stock Exchange because, with three-day settlement and the exchange being closed for Christmas Day December 25 (Monday) and Boxing Day December 26 (Tuesday), it is the last day of the year you can sell and have your sale registered as occurring in 2006.

The capital gains or losses donít have to be from stocks. They can be from selling other securities, such as bonds, mutual funds, or exchange traded funds (ETFs), or even from real estate.

But be warned that, as with most things related to the Income Tax Act, it is important to follow the rules in how you take and claim your losses.

If you want to be able to claim the capital loss from selling a stock, you (or someone related to you) cannot repurchase the same stock within 30 days of the sale. 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 in the same sector (for instance selling one oil sands company to buy another).

Another rule introduced in 2004 says that you cannot claim a loss on any security bought within your or your familyís RRSP within 30 days. This means you cannot trigger a loss simply by transferring a security from a non-registered account into an RRSP.

Investors should also check their mutual fund or ETF holdings to see if capital losses can be harvested there.

You could generate claimable losses and still keep your stock market exposure by switching from an equity mutual fund into an ETF replicating the S&P/TSX Composite Index or visa versa.

However, it wouldnít be within the rules to sell one index fund based on the S&P/TSX Composite Index at one institution and buy an ETF based on the same index or another index fund based on this index from another financial institution. Tax authorities would consider all three of these to be identical property and would reject the claim.

There is also a special tax rule that applies in the case where an investor owns shares that have simply lost all value such as from bankruptcy. You donít have to actually sell these to trigger a capital loss. Instead, you can claim the capital loss if you attach a note to your tax return explaining the situation and reporting that the shares have been disposed of for no proceeds.

You can claim a loss in this way even if the company hasnít formally declared bankruptcy as long as the company is insolvent, it is no longer carrying on business and it is unlikely to do so in the near future, and the fair market value of the shares is zero.

Of course, since you still own the stock, if a miracle somehow revives the company and you eventually sell the investment, you would have to report a capital gain at that time.

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. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.

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©2006 Wayne Cheveldayoff