Tax loss harvesting may be a new term for many Canadians, but it’s a simple concept that can be easily understood with a few guidelines. In 2022, with the market being volatile and fluctuating, it’s the perfect year to recover losses. Tax loss harvesting involves selling underperforming assets for less than their purchase price to generate a tax loss that can offset realized capital gains in any part of your portfolio. Wealth managers often use this technique to adjust the asset weightings in their clients’ portfolios.
What is tax loss harvesting and how does it work?
In a non-registered investment account, a capital loss is incurred when an investment is sold for less than its Adjusted Cost Base (ACB). The ACB is the purchase price plus any additional acquisition charges like commissions or legal fees. Capital losses can be used to offset capital gains within the same tax year, which is where tax-loss harvesting comes into play.
Tax-loss harvesting involves selling underperforming investments in a portfolio for a loss in order to offset any realized capital gains and reduce the tax burden. It is a common practice in portfolio management, especially during periods of market volatility. Capital losses can be carried forward indefinitely or applied to the previous three years’ capital gains, making it a versatile tax planning tool.
Strategies to consider for tax loss harvesting:
- Portfolio Restructuring One strategy to restructure a portfolio is through tax loss harvesting, which involves paying close attention to the cost basis of each asset to adjust the initial purchase price. This makes it easier to calculate capital losses or gains for each asset, enabling investors to offset capital gains from the current tax year or carry forward losses indefinitely.
- Superficial Loss/Wash Sale Rule When utilizing tax loss harvesting, it is important to follow the guidelines set forth by the Canada Revenue Agency (CRA), including the superficial loss criterion. This law prohibits investors from repurchasing the same investment within 30 days after selling it if they are claiming a capital loss. If an investor sells a capital property at a loss and then repurchases identical assets within 30 days of the sale, the CRA’s superficial loss criterion will apply, preventing investors from subtracting capital losses from their yearly income to reduce their tax obligations.
- Investment Strategy The type of investment in a portfolio can affect the ease of implementing tax loss harvesting. It is easier to implement with a portfolio composed of individual equities or exchange-traded funds, while investing only in mutual funds might be more difficult since mutual funds may pay yearly capital gain distributions, requiring investors to pay Canadian capital gains tax on half of the total amount. Therefore, it is important to consider your investment strategy when planning for tax loss harvesting.
What advantages can tax loss harvesting offer?
When dealing with capital gains and losses on your taxable investment accounts, there are several factors to consider. Below are some benefits of tax loss harvesting:
- It can help to lower your tax liability in non-registered investment accounts.
- It can minimize the negative impact of losses within your portfolio.
- It can be combined with portfolio rebalancing to optimize your asset mix.
- It can be used strategically to save money on taxes in the future.
- If you are not taking a hands-off approach, it may be wise to consult with a tax professional before implementing your tax-loss harvesting strategy.
This blog explains tax loss harvesting, a simple yet effective strategy for reducing tax liability by selling underperforming assets at a loss to offset realized capital gains in a non-registered investment account. The year 2022 is an ideal time for this due to market volatility. The adjusted cost base (ACB) of an investment is the purchase price plus additional charges. Capital losses can be carried forward indefinitely or back up to three years. Investors must follow the Canada Revenue Agency’s (CRA) superficial loss rule, which prohibits repurchasing the same investment within 30 days after selling it at a loss to claim a capital loss. Mutual funds pose a challenge to tax loss harvesting due to yearly capital gain distributions, which trigger Canadian capital gains tax.