WHY CRA WILL DENY YOUR CAPITAL LOSS - YouTube

Hi everyone and welcome back to the Independent Dollar as we are now over half way through

our February Tax Tips & Updates Series.

If you’re joining us for the first time, we make personal finance videos each week,

breaking down topics in a way that is straightforward and easy to understand.

Today’s video is all about tax-loss selling, superficial losses - what they are and ways

around them, and some common transactions that can derail your investment tax strategy .

What is tax loss selling?

Tax loss selling, or tax loss harvesting, is a strategy investors use to reduce the

amount of capital gains that you owe at the end of each tax year.

While we always want to have as many capital gains as possible - meaning, we want our investments

to grow as much as possible - we obviously don’t also want to pay as much tax as possible.

Strategically deciding when to sell our investments can have a huge impact on the amount of taxes

that you will owe.

Before we dive in, it’s important to understand how capital gains and losses are calculated.

Whenever we buy an investment in a non-registered account, we establish a distinct purchase

price for our investments.

When we sell our investment, the difference between the selling price and the original

purchase price is what is referred to as our capital gain or our capital loss.

Another term for our purchase price is book value, or adjusted cost base (ACB) - and I

will explain that term shortly as it is very important to understand.

Here is the formula for calculating your capital gains: Capital Gain/Loss = Proceeds of Sale

- Adjusted Cost Base - Outlays and Expenses

Let’s take a look at an example.

Assuming we purchased $1000 worth of XYZ Stock, and later sold it all for $1,200,

that would be a gain of $200.

To keep things simple, we will assume there were no fees to sell, but in most cases you

will want to deduct your Outlays and Expenses.

Outlays and expenses are the costs you pay in order to sell your stock, an example of

this would be the broker fee or commission you paid when you sold.

In this case, we we sold more than what we purchased it for, so our capital gain is $200.

Similarly, if we had instead sold the stock when it was at $800, that would be at a capital

capital loss of $200.

When we look at our financial statements, an investment will not have a capital gain

or loss until the position is sold.

If we bought the shares at $1,000, watched them rise to $1,200 and then fall to $800,

but did not sell at any point, you have not realized any capital gain or loss.

So an opportunity exists at the end of each calendar year, for you to look at your investments

and strategically sell to realize gains or losses.

But why would you do that?

It's simple - we want to minimize the amount of taxable capital gains that we have each year

Looking at our portfolio again, let's envision that we purchased two different stocks - one

that rose from $1,000 to $1,200 and the other that dropped from $1,000 to $800.

If we decided to sell our position in the stock that was sitting at a profit, we would

have incurred $200 in capital gains which we would now be taxed on.

However, if we decide to also sell our investment in the second stock that had a capital loss

of $200, we have offset the capital gain completely and pay $0 in taxes.

This is because in Canada, Canada Revenue Agency allows us to use our capital losses

against our capital gains.

Similarly, the opposite situation may occur.

You've had enough of holding onto a losing investment that is now down $200 and you decide

to sell it.

As capital losses are quite useful, you look at your investments and see another stock

that has gained $200 and decide to sell it now while you have a capital loss available.

If you had waited until next year to sell, the loss and gain wouldn't line up and the

tax implications would apply.

Now a few of you are aware that there is something that we are skipping over, and oversimplifying

our example - and that is carry forward/carry back rules.

In Canada, any capital losses occurred in the current year must first be used to offset

any capital gains from that year.

Any capital losses left over however, are permitted to be carried back three years to

offset previous capital gains, or carried forward indefinitely to be used against future gains.

This removes some of the urgency to buy or sell investments right away to take advantage

of the tax loss selling technique.

In our experience though, it is much simpler to try and keep all transactions, gains and

losses, within a single tax year, instead of trying to strategically spread them over

multiple tax years.

However if you do find yourself in a situation where you have unintended excess capital losses,

it is well worth the time to look at the past few years of taxes for opportunities to recoup

taxes paid.

Now we should quickly pause here and state that everything we are going to be talking

about next, is in regards to our non-registered accounts, for the most part.

If you hold all your investments in an RRSP/TFSA/or any other registered account, most of this

will not apply.

That being said, You do have to be cautious if your spouse or any other affiliated person

has investments in non-registered accounts.

This is very important and we will touch on that near the end as we move through

superficial losses.

So what exactly is a Superficial Loss and why do you need to know about it?

In our previous example, it is an ideal situation - you have a stock that is at a gain and a

stock that is at a loss, and you have no vested interest in continuing to hold

either one of them.

But what if you're in a situation where one of the stocks is in a company that you believe

is poised to breakout and take off, and you would like to keep investing in it?

One mistake investors will make, is selling the position that is down in value, triggering

the capital loss, and then repurchasing it back again.

The CRA, and other tax agencies worldwide, have a rule in place called

a superficial loss.

The details and rules of each are different, but the constant of them all is this: An investor

cannot sell an investment at a loss and then immediately repurchase it,

and keep that capital loss.

In Canada, the investor has to wait 30 days to repurchase the stock in their portfolio,

or a superficial loss adjustment takes place.

Looking at our previous example again, if you had bought and sold your two positions

at $1,200 and $800, you would have an offsetting capital gain and loss.

However, if you decided to repurchase the exact same stock within the next 30 days,

the CRA would deem that to be offside and issue a superficial loss adjustment against

the repurchased stock.

This means that your capital loss would be denied, and your Adjusted Cost Base will be

adjusted on your new purchase.

To help simplify this, let's take a look as a basic example so you can understand visualize

what we mean:

You purchased both Stock A and Stock B for $1,000 each.

After selling stock A, you have a capital gain of $200 and so you decide to sell Stock

B which is at a loss of $200 to help offset the capital gain.

When you decide to repurchase stock B at $800 within the 30 day window, you are hit with

a superficial loss adjustment and your capital loss is denied.

This in effect resets your Adjusted Cost Base back to its original value before you engaged

in selling and repurchasing.

The recent purchase of Stock B now looks as follows:

The capital loss of $200 is denied, meaning you will have to pay capital gains tax on

the other stock that you sold.

While the purchase price is $800, you incurred a superficial loss adjustment so your new

cost base is now $1,000 and not $800.

Now let's take a look at some common transactions that are often assumed to avoid the superficial

loss adjustment, when in fact, that is not the case.

Over the years, the CRA has become wise of other ways taxpayers attempt to skirt around

the 30 day limitation and have instituted more restrictions - the most “popular”

of them are these 3: TRANSFERS FROM NON-REGISTERED ACCOUNTS TO REGISTERED.

If an investment is sold in a non-registered account and then repurchased in another account

within 30 days (e.g. RSP, TFSA, RIF, etc), the capital loss will be denied and this will

also trigger a superficial loss adjustment.

AFFILIATED PERSONS If an investment is sold by one individual

and then repurchased by an “affiliated person” like your spouse for example, a corporation

controlled by you or affiliated person, or a trust where you or an affiliated person

is a majority beneficiary, the capital loss will be denied and a superficial loss adjustment

will be applied.

PURCHASING IDENTICAL PROPERTY Purchasing an identical property like selling one ETF

and purchasing another ETF that tracks the exact same index,

or a different series of the same mutual fund for example, are not permitted.

Like the previous examples, the capital loss will be denied and a superficial loss will

be applied.

There are many more intricacies to superficial losses, but the rule of thumb is to wait 30

days before repurchasing the same investment in any of your accounts or before an affiliated

persons purchasing the same investment.

If you are selling an investment where you want to maintain a market position, a method

you can use is to purchase a broad market, or sector specific ETF.

To show you what we mean, lets take a look at an example:

You hold shares in one of the 5 canadian banks and want to realize a capital loss.

In this case, you would be permitted to sell your bank stock, and go out and purchase a

Canadian Financials Index ETF.

If there is any movement in the Canadian Banks in the 30 days (up or down), you will participate

in it, and this would not be considered an identical property, so no capital loss would

be denied or superficial loss adjustment applied.

After the 30 days, you can sell your ETF and repurchase the bank stock of your choice.

Similarly, if you sold a group of US stocks to harvest their capital losses, you can purchase

a broad based US index ETF.

But be aware that not all investments in the US are alike, as we mentioned in our ETF vs

Mutual Fund taxation video.

The world of capital gains and losses can be quite confusing, but with a small bit of

time and research, the gains can be huge.

The ability to offset your capital gains or losses to minimize taxes can have a measurable

effect on your total return and should be looked at the end of each calendar year.

Like always, we would recommend consulting with an advisor in this situation to know

all of your options.

This wraps up our lates video in our Tax Tips & Updates Series.

If you have any questions, let us know by commenting below, and if you found the video helpful,

give us a thumbs up to let us know so we can put out more videos like this.

Thank you so much for watching and we'll see you back here on Tuesday.