This is the time to consider a tax-loss sale. In the next few days review your stock market triumphs and disasters over the past 4 years. Sales of portfolio losers before year-end could generate a big tax refund.
Stock market volatility and price declines during the past couple of years have stressed investors. Many stocks and other investments have taken major price hits. Portfolio values are down dramatically. While no investor likes to sell at a loss, now is the time to consider tax-loss selling for non-registered investments. It's about the only silver lining in the dark cloud of falling stock prices.
How does tax-loss selling work?
You can use capital losses taken in a given year to offset capital gains in the same year. Any remaining loss can be used to reduce taxable capital gains in any of the 3 preceding years or in any other future year.
To maximize the benefit for each dollar of losses, your best strategy is to carry the losses back to the earliest year in which you had capital gains. For 2012 you can carry losses back as far as 2009, a time when your stock portfolio may have realized a taxable gain. If you don't apply your 2012 losses to your 2009 gains on this year's tax return, you lose the opportunity since 2009 will drop out of the 3-year carry-back window in 2013.
When you carry a loss back into a year when the inclusion rate (percentage of capital gain included in income) was different from this year, the loss is adjusted to match the inclusion rate in the year the capital gain occurred. (This is not the case for 2009 to the present.)
Here are some things to keep in mind when tax loss selling:
First, neither you, your spouse nor a corporation controlled by either of you can purchase identical stock within 30 days before or after your sale. If you do, Canada Revenue Agency (CRA) will declare the sale a superficial loss, and deny you the loss (but not for ever - it's added back to the adjusted cost base of the repurchased stock). Remember this in selecting losers to sell. If you think a stock just might recover some or all of its value within that 30-day period, it may not be a good candidate for tax-loss selling.
Some investors have, however, found ways to get around this 30-day rule. One way is to find 2 investments that are very much alike but not considered identical by CRA. Various mutual funds, for example, have very similar make-up but are not identical by CRA definition. You can sell the losing fund you currently hold and then immediately purchase a similar fund.
The 30-day rule can be used to transfer losses to a spouse who might be in a higher tax bracket or have significant capital gains that need to be offset. You sell the stock to your spouse at fair market value secured via cash, a loan bearing interest at CRA's prescribed rate (variable rate that changes every 3 months), or other assets. Since your spouse buys the stock within 30 days of your selling it, you are denied the tax loss.
But the loss is added to the cost base of the stock in your spouse's hands. After 30 days your spouse may sell the shares and realize the loss. Your tax return must state, however, that an inter-spousal transfer took place at fair market value and the spousal rollover provisions do not apply.
You also can use tax-loss selling to flip a losing investment to your children. You can give the shares or units to them. Or you can sell to them at the current market value. You then can claim the appropriate tax loss. If the investment increases in value down the road, your child would be eligible for tax on the capital gain - but if he/she has no other income, the gain should be tax-free.
Finally, you can sell an investment in your non-registered portfolio and repurchase it simultaneously in your Registered Retirement Savings Plan (RRSP). It won't be considered a superficial loss, but of course you need to have RRSP room available.
The superficial loss rules and tax-loss selling is not a simple proposition. If this is something you want to consider, make sure you consult your tax advisor in advance. And if you decide on tax-loss selling in the current year, sell before Christmas. To ensure the transaction is completed before the December 31 deadline, you need to allow for the combination of holidays and the 3-business-day settlement period required on most sales.