Use tax-loss selling to offset your taxable capital gains in Canada.
Tax-loss selling (or tax-loss harvesting) occurs when you deliberately sell a security at a loss in order to offset capital gains in Canada. You can then use these losses to offset your taxable capital gains.
As a reference, the 2015 deadline for tax-loss selling on the Toronto Stock Exchange was December 24, 2015. If you sold at a loss on or before that date, you could deduct your loss against your 2015 capital gains. However, you can also carry your loss back for the previous three years (2014, 2013 and 2012) to offset capital gains in Canada, or carry it forward indefinitely, to offset past or future capital gains.
As Canadian capital gains tax is lower than the tax on interest and on dividend income, capital gains is a very tax-advantaged form of income. However, since most investors have income of all three types, here are three strategies for structuring investment portfolios to minimize the tax burden.
- It is usually best to hold any common shares outside of an RRSP (as dividend income and capital gains taxes are taxed lower than interest income), and interest-paying investments in an RRSP.
- More speculative investments are best held outside of an RRSP. If investors hold them in an RRSP and they drop, investors not only lose money, but they can’t use the losses to offset any taxable gains from other investments.
- Regarding mutual funds outside an RRSP, the main consideration is that mutual funds make annual capital gains distributions even if investors continue to hold the fund units. Investors then pay Canadian capital gains tax on half of any realized capital gains. So you are best to hold mutual funds in an RRSP and common stocks outside. You won’t realize capital gains on common stocks until you sell.
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A properly structured investment portfolio can let you take advantage of the low tax rates on capital gains and dividend income while sheltering your higher-taxed interest income in your RRSP. If you make dividends or capital gains in an RRSP, you gain the tax shelter of the RRSP, but when you withdraw the funds from your RRSP they are taxed at the same rate as interest income. This means you would lose out on the lower tax rates offered.
What to be aware of regarding capital gains tax in Canada
If you are considering making use of tax-loss selling to minimize capital gains in Canada, you should also be aware of the “superficial loss rule.” This rule states that if an investor, their spouse or a company they control, buys back a stock or mutual fund within 30 days of selling it, then they are not permitted to claim the capital loss for tax purposes. Failing to obey the 30-day rule will result in the capital loss being disallowed.
There are some ways to keep exposure to stocks during the 30-day period. For example, if you decide to sell your resource shares to realize a capital loss, but then you decide that resource stocks are poised for a rebound, you can buy a resource-heavy exchange-traded fund (ETF) to keep yourself exposed to that sector. Or you could buy shares in a company that is in a similar business as the one you sold (such as selling TransCanada Corp. and buying Canadian Utilities).
It’s always a good time to sell bad stocks, or stocks that are wrong for your portfolio. But you need to balance that rule against the fact that in the final couple of months of the year, some investors dump stocks without thinking, just to cut their taxes. In some cases, they simply want to sell and be done with it. In others, they intend to buy the stock back after 30 days (as we mentioned, if you buy back any sooner, you cannot deduct your loss.)
As a result, stocks that have been weak tend to stay weak in the final month or two of the year. But the best of the bunch can put on extraordinary recoveries when tax-loss selling season ends.
Our advice: Don’t let tax considerations spur you to make a costly mistake. You can always sell next year and carry your loss back.
Did you find my tips on capital gains tax helpful? Please share your thoughts in the comments section.
This post was originally published in 2015 and is updated frequently
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