What is tax-loss harvesting?

 

Tax-loss harvesting, also referred to as tax-loss selling, can be used by investors with non-registered investments (stocks, bonds, mutual funds and ETFs) that are trading below their original cost. These investments can be sold, and the subsequent capital loss can be used to offset any capital gains incurred that tax year. It’s also possible to carry capital losses back into the previous three tax years and/or carry them forward indefinitely.

 

One consideration for investors when employing tax-loss harvesting is the “superficial loss” rule. This rule states that if an investor buys back the same security within 30 days of sale, the tax benefit from the capital loss will be nullified. At first glance, the superficial loss rule appears to limit the options for investors. For example, an investor who sells shares of a Canadian bank at a loss later sees indicators that the Canadian banking industry may be poised to regain some ground. However, the investor cannot repurchase shares of the same bank within 30 days without invalidating the sale as a capital loss.

 

There are, however, tax-loss harvesting strategies that allow you to maintain exposure to a particular stock or sector while still realizing a capital loss.

 

Tax-loss harvesting examples

 

Going back to our example, after the investor sells their bank shares at a loss, they could then purchase a Canadian bank stock ETF or a Canadian equity mutual fund with a large exposure to the Financials sector. The investor will gain the tax advantage of the capital loss from the sale of the bank stock and be able to retain exposure to the financial industry because the ETF or mutual fund is considered “materially different” from the original position. While this solution will not provide the exact same exposure to the investor’s previous position, it enables the investor to participate in a potential rebound in the sector.

 

Important factors to keep in mind

 

When it comes to tax strategies, it is critical to remember that circumstances vary from individual to individual. While no set of guidelines applies to every investor, investors should keep the following in mind when considering a tax-loss harvesting strategy:

 

Always consult with a tax specialist before planning or enacting a tax-loss strategy.

Investors need to closely monitor end-of-year deadlines for completing a tax-loss sale to ensure that the transaction is finalized in time to apply to the current tax year (if that is desired). Remember, settlement dates are typically two business days after a sale is initiated