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Things to Know About Tax-Loss Selling

Things to Know About Tax-Loss Selling

Tax-loss selling, a.k.a tax-loss harvesting, is a strategy available to investors trading below their original cost in non-registered accounts. These investments can be stocks, bonds, mutual funds, and/or exchange-traded funds (ETFs). The strategy is to sell these investments and use the subsequent capital loss to offset any capital gains realized in that year. It is also possible to carry forward losses from the previous three years and/or carry them forward indefinitely.

Transfers of securities must be settled within the calendar year to offset capital gains realized in the same year (or the previous three years). Remember that settlement dates are usually two business days after a sale begins, so the last day of a loss sale is usually at least two days before the last day of December.

How tax-loss selling works

When it comes to the concept of investing, the basic process involves:

  • Setting short and long-term goals.

  • Identifying risk tolerance.

  • Making decisions based on these factors to generate profit.

Going further, a crucial part of the process also includes managing these gains and related tax results because the reality is that taxes are a real consequence of investing. Only this underscores the importance of integrating strategies to deal more effectively with the consequences, and this is where techniques such as tax-loss selling come in. Although this article covers some considerations and particularities of selling at a loss, it is only one of many options and approaches to consider. 

With a tax-loss selling strategy, several investments that have declined in value have been sold to generate a tax loss, which is then used to offset capital gains already realized during that period. Alternatively, a current year aggregate net capital loss can be carried forward and applied against net capital gains realized in the past three years or can be carried forward for use in a future year.

The amount of taxable capital gains each year is based on the calculation of net capital gains, which accounts for the sum of all capital gains minus all realized capital losses for the year. Therefore, to the extent that an investor incurs a capital loss in the same financial year in which a large capital gain arises, the capital gains tax may be reduced (or eliminated).

That said, it may be worth reviewing your portfolio with your financial professional to consider selling some investments with unrealized losses, provided the sale makes sense from an investment perspective.

Considerations before Implementing a Tax-Loss Selling Strategy

Before implementing a loss-selling strategy, consider the following:

Losses can be applied to the current year or previous year profits

Losses are first applied to offset current-year capital gains. Still, any net (total) loss that is not applied can be carried forward for up to three years, so it is important to review the capital gains and losses realized to determine if you reported net capital gains in any of those years. If so, consult your tax advisor to understand the potential tax benefit of applying any net capital loss to offset such gains.

Foreign currencies

Please note that any capital gain or loss on foreign securities denominated in another currency is calculated in American dollars, even if the sale proceeds remain in foreign currency. The exchange rate at the time of purchase is used to calculate the tax cost basis, and the foreign currency exchange rate at the time of sale is used to calculate the sale proceeds. Therefore, fluctuations of the foreign currency against the American dollar during the period of ownership will also be taken into account in the analysis.

Confirm the tax base of the security

Speak to your accountant or other tax advisors to confirm the actual tax cost of your investment. The tax cost basis often differs from the original purchase price due to corporate reorganizations, tax options, distributions (such as the return of capital), or the requirement to calculate a weighted average cost for tax purposes of a security that is held across more than one non-registered account.

Be aware of the superficial loss rule.

The superficial loss rule under tax law can prevent a capital loss on the sale or disposition of an investment. The rule generally applies if:

i. Within the period beginning 30 days before the sale and ending 30 days after the sale, you or any person or entity considered to be affiliated with you for tax purposes acquired the same security or identical security

ii. At the end of the period, you or an affiliated natural or legal person held or had the right to acquire the same or identical security. Business investors should be aware of rules similar to the superficial loss rule for those who will deny and "suspend" capital loss in the business. Business investors should also take note of another stop-loss clause which may offset a capital loss where the corporation has received a deductible dividend on a stock prior to the sale of the loss-making shares unless the investor corporate has not owned the shares in the last 365 days and has not owned more than 5% of any class of shares of the company that pays the dividends.

Pay attention to the settlement date.

Since the trade settlement date is tax-relevant (i.e., it usually takes two business days from the date of the trade for an equity trade to settle), make sure that there is sufficient time after the trade date for the trade to settle.


Seek Professional Advice

Be sure to consult your tax advisor before implementing a loss selling strategy to ensure it is appropriate for your situation and executed correctly.



Tiffany Gaskin
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