Towards year-end, you’ll hear about “tax-loss selling” if you’re an investor. This refers to the strategy of triggering losses before December 31 in order to offset capital gains you may be facing for 2014. Of course, it’s never quite as cut-and-dried as it appears. In fact, there’s a bit of an art to it.
So the real question is: “How do you trigger a loss?” One easy way is to look at the stocks or other investments in your portfolio to see which are in a loss position (i.e., where the current market value is less than the cost to you). By selling such investments in a loss position, you can trigger a loss.
Why trigger a loss?
Yes, this means you aren't making any money off these sales. However, it also means the loss that results can be used to offset the gains, which could cut your tax bill.
Sounds easy doesn't it? But before you place your sell order, here are some other things to watch for:
Do you need a tax loss? If you don't have any capital gains as far back as 2011, there's no need to run out and sell a loser just for its tax loss. (Capital losses can be carried back only three years.) That's because capital gains can be claimed only against capital losses. For most investors, the result will be a capital loss.
Keep in mind that a capital loss cannot shelter income from your job, a business or even an employee stock option benefit. So if you have no capital gains, then there's no point in tax loss selling.
A possible exception applies to losing investments in Canadian private corporations devoted to active-business endeavours – this could include over-the-counter traded stocks.
Do you have a tax loss? You probably are thinking it's likely you are sitting on at least a couple of losses. However, don't assume this is the case.
Whether you actually have a tax loss to begin with depends on the tax cost of your investment - or as we tax drones call it, your "adjusted cost base." One important thing to bear in mind is that you must calculate your tax cost on a weighted average basis for all identical investments.
Calculating your tax cost on a weighted-average basis
Let's say that you bought 2,000 shares of Xco at $20 per share and another block of 1,000 at $40. Supposed, too, that you decided to take your lumps on the second purchase and you sold the block of 1,000 at $30. Your loss would be $10 a share, right? Wrong!
You have to calculate your cost on a weighted average basis. Since most of your shares were bought when the stock was below its selling price, the weighted average cost per share would be $36.67. Here’s the math: (2,000 x $20 + 1,000 x 40)/3,000. Crunch these numbers and you get $80,000/3,000, which works out to $3.33. So that apparent $10 loss is in fact a $3.33 gain per share.
You must use this approach even if you used a different broker for each purchase. Happily, though, initial purchases by other family members will not figure in the weighted-average calculation. For this reason, it may make sense to have other family members make the initial purchases, in order to "isolate" cost base in each person. If in our example your spouse had purchased the second block at $40 and later sold it, your spouse's adjusted cost base would have been based on the $40 amount.
Next time: Advanced tax-loss selling strategies, including mutual fund sales.
Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-editor of various Wolters Kluwer Ltd. tax publications. Portions of this article first appeared in The TaxLetter, published by MPL Communications Ltd., © 2014, used with permission.
The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.