As year-end approaches, you start thinking about family and planning for the holidays. Embrace the spirit of the season, but don’t forget about tax planning.
The end of the year is a good opportunity to ensure that you’ve taken the steps required to minimize taxable gains and effectively manage investment losses. One tax-reduction strategy that’s especially relevant at this time of year is tax-loss selling.
Investing and taxes
Whether you choose to invest in mutual funds, exchange-traded funds, stocks, bonds or some combination of these securities, your ultimate goal is to grow your wealth by increasing the value of your investments.
If you sell one of your securities at a value that is higher than what you paid, you may earn a “capital gain.” This gain represents the difference between your purchase cost and the “proceeds of disposition” (i.e., the money you receive when you sell the investment). Capital gains are subject to taxation when you file your income tax return for the year in which this gain was earned.
Here’s an example to illustrate how capital gains work. Let’s say in 2016 you bought 1,000 units of XYZ mutual fund at $12 per unit. Your total purchase cost was $12,000 – for this basic example, we will ignore factors like sales charges, fees, reinvested dividends, etc.
XYZ mutual fund has performed well and the unit price has reached $14.50. We discuss this fund and decide it’s a good time to sell because the fund no longer suits your investment time horizon. Since you own 1,000 units, your investment is now worth $14,500 and your capital gain is $2,500 ($14,500 - $12,000).
Reduce taxes with tax-loss selling
Here’s where the strategy of tax-loss selling is valuable. To reduce your tax obligation, we may decide to sell one of the funds you own that is trading below your purchase price. For example, in 2017 you bought 5,000 units of ABC mutual fund at $7.00 each (total cost of $35,000). The fund has struggled and its unit price has declined to $6.50. We’re not confident about the fund’s future prospects so we sell the 5,000 units and you receive $32,500 as the proceeds of your sale. Your capital loss is $2,500 ($32,500 - $35,000).
If XYZ and ABC funds were the only securities you sold this year, then you can offset the $2,500 capital gain that you earned from your sale of XYZ fund with the $2,500 capital loss incurred when selling ABC fund. As a result of these offsetting trades, you won’t need to pay any tax on the sale of your securities.
Tax-loss selling can reduce or eliminate the income tax burden related to your investments. We can review your tax situation and decide whether tax-loss selling is necessary or desired.
If we do take advantage of tax-loss selling in your investment account, any trades must be completed at least two business days before the end of the calendar year, in order for the trade to “settle” (i.e., be processed) in time to count for this tax year.
Keep in mind that immediate taxation of capital gains only applies to non-registered accounts. If you make gains in registered accounts like an RRSP or RRIF, then taxation on any capital gains earned will be deferred until you begin withdrawing from the account. If you profit from the sale of securities in a TFSA, then capital gains tax does not apply at all.
Contact our office for more information about tax-loss selling and whether the strategy may apply to your particular tax situation this year.
Disclaimer: This is for information purposes only and should not be construed as investment advice, investment decisions, products or services, offer in any jurisdiction in which such solicitation or offer would be unlawful. Please consult your own tax planning advisor.