Give Yourself a (Tax) Break: How Selling Stocks at a Loss Can Save You Money

Give Yourself a (Tax) Break: How Selling Stocks at a Loss Can Save You Money

It’s almost that time of year again. As the holiday season approaches, the time has come to decorate the Christmas tree, light the menorah, invite hoards of family members over, and begin doing all of those special traditions that make the holiday season so wonderful.
 
Beyond the turkey dinners, holiday shopping, and carol-singing, it is also that special time of year to engage in another cherished tradition that accompanies the end of the calendar year – tax-loss selling. While it may not seem as fun as drinking hot cocoa by the fire with your family, tax-loss selling provides investors with an incredible opportunity to save money by minimizing their tax liability on capital gains by generating a loss that can decrease their tax bill.
 
Before we get into the details of the tax-loss selling strategy, let’s review capital gains and the tax implications associated with them.
 
 
Capital gains and taxes
 
A capital gain occurs when any ‘capital property’, such as securities in the form of shares and stocks, are sold for a higher value than you purchased them for. Capital gains that are realized on the sale of appreciated stocks must be claimed on your annual income tax return and will be subject to taxation.
 
In Canada, 50% of your capital gains are included in your total amount of taxable income, which gets taxed at your marginal tax rate.
 
For example: if your capital gain on the sale of a stock is $20,000, only $10,000 of that is subject to being taxed. Assuming you fall into the 40% income tax bracket, this means that you will owe $4,000 in taxes on that capital gain.
 
 
So, how will tax-loss selling help to offset the capital gains taxes that you owe?
 
 
What is tax-loss selling?
 
Tax-loss selling is a strategy that investors employ to reduce the amount they owe in taxes. Essentially, if you have securities that have experienced a decrease in value since the time you bought them, you can sell them and use the capital loss to offset the capital gains that you have in that current year.
 
Admittedly, the concept of tax-loss selling may seem unsettling or troubling to investors as it runs counter to traditional investment practices centred on the principle of “buy low, sell high”.  While the tax-loss selling strategy may not necessarily be right for all investors given individuals’ diverse investment goals, risk tolerance levels, and time horizons, embracing the tax-loss selling strategy can provide you with significant tax savings. All it requires is a fundamental shift away from this traditional view of investing and a comprehensive understanding of the securities in your portfolio.
 
For example: Going back to the previously stated scenario, let’s say you have $20,000 in capital gains in a given year (only 50% are subject to tax) and are in the 40% tax bracket, you will owe $4,000 in capital gains taxes. Your investment portfolio also holds a specific stock that has greatly decreased in value and would result in a $10,000 capital loss if sold. By selling this stock, your capital gains (and the taxes associated with such) are offset to be $10,000, resulting in a tax bill of $2,000, rather than $4,000.
 
When filing your taxes, you must first apply any losses you have against capital gains from that current year. After you apply them against the current year’s capital gains, if you still have a net loss, you are allowed to apply them retroactively for up to three years, or forward indefinitely.
 
**It is important to note that only non-registered assets qualify for this tax-loss selling strategy. If a stock has dropped in a registered account such as your Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP), you cannot use it to offset capital gains.
 
 
What stock should I sell at a loss?
 
Given the significant tax-savings that you can realize by balancing your capital gains with losses, wouldn’t it make sense to sell off all capital losses until the point that my gains are zero?
 
The simple answer is: not necessarily. As a general rule, it is better to consider investment fundamentals before considering tax consequences.
 
Typically, when selling securities at a capital loss, you should only be selling those belonging to companies that are in trouble and seem unlikely to recover. Don’t just sell any stocks that are currently at a loss because stocks can rebound.
 
While a thorough examination of the company’s financial situation and forecasts will help to determine the company’s viability, it is also important to look to the general societal trends, as well. Political, economic, social and technological trends will be major determinants of which companies the government and consumers will likely continue to support.
 
 
Is there a deadline?
 
For a capital loss to count in a current year, the sale has to settle on or before December 31st of the given year.
 
Remember: the ‘settlement date’ is three business days after the date the trade was made. Considering the fact that Christmas and Boxing Day are statutory holidays, the last day to take advantage of capital losses on Canadian stocks through the tax-loss selling strategy for the 2019 year is December 24th.
 
If a trade is made and settled after that date, for tax purposes, the capital loss will be recorded for the following year. By being proactive and re-assessing your investments now, you are ensuring that you do not miss out on tax-savings due to a lack of preparedness.
 
 
Can I sell and repurchase the same stock?
 
Even with the tax-savings capital loss selling offers you, you may still be thinking of more ways that you reduce your tax bill. If your capital losses haven’t entirely offset your capital gains, meaning you are still liable to pay taxes on a portion of your gains, you may be thinking “can I just sell and then repurchase the same stock?” This way you get to reduce your tax bill by selling stock that may only temporarily be at a loss, but then repurchasing it again.
 
You need to be very careful if you are thinking about this. Here’s why:
 
Superficial losses.  If you sell a stock and repurchase that same stock within 30 days – either before or after the sale date, the CRA classifies this as a ‘superficial loss’. With a superficial loss, you cannot use the loss to offset capital gains.
 
This rule applies not to your specific investment accounts, but rather your household. This means that you cannot sell stock from one account to offset capital gains and then repurchase the same stock in a different account. Relatedly, you cannot sell a stock from one of your accounts to offset gains and then repurchase the same stock in one of your spouse’s accounts. Simply put, you are not eligible to claim a tax loss if you, or someone affiliated with you, retains control of the shares.
 
Repurchasing similar, not identical stock.  There are some ways to get around superficial losses. If you are trying to take advantage of tax-loss selling by selling off a stock in an industry that you think is temporarily down but will eventually recover, selling your stock and then repurchasing some in a similar (but not identical) company, will allow you to circumvent superficial losses.
 
For example: The price of oil has plunged, which has resulted in the value of an energy stock you own to plummet, as well. By selling the stock and then immediately purchasing stock in a different, but similar, energy company, you are triggering a capital loss to offset your gains, while also maintaining your investment in the energy sector. This can be a tricky strategy to employ successfully considering the unpredictability that accompanies the downturn of an entire industry. This should only be employed if you have a positive long-term outlook of the industry.
 
 
‘Tis the season
 
As the end of 2019 comes into sight, not only is it the time to take a look back and reflect on all that has happened in the last year, but it is also the time to look forward and reassess your personal goals and by extension, your financial goals. Review your personal financial health, assess your investment portfolio’s performance, rebalance or adjust your portfolio (if necessary), and explore ways you may be able to reduce your tax liability.
 
While it is true that when done correctly, tax-loss selling can be an effective investment strategy that can save you big bucks, it is important to acknowledge that like any strategy, tax-loss selling is just that: a strategy. It only works if you have an actual loss and are ready to sell. It also simply may not be a suitable strategy for you to pursue given various factors related to your personal and financial priorities.
 
If you have any questions about tax-loss selling or other ways to minimize your tax bill by the end of the year, please don’t hesitate to reach out to me or any of the knowledgeable team members at Bongard Wealth Advisory for advice.