Making effective use of capital losses

Just as an appreciation in price can lead to a capital gain, a decrease in price can result in a capital loss. In an investment portfolio, capital gains and losses may apply to individual securities or to pooled securities like mutual funds. For the purposes of this article, we’ll use the term “security” as a short form reference to both.

As with capital gains, capital losses are unrealized until there is a taxable event. Half of the capital loss, known as the allowable capital loss, can be applied to offset the taxable half of capital gains.

Applying capital losses

Capital losses realized in a year must first be used against capital gains that same year, with the investor then having discretion to apply any unused excess against capital gains in any of the three preceding tax years, or to carry those losses forward for future use.

For an investor who realized and reported capital gains in 2021, then 2024 is the last year to carry capital losses back and amend/re-file that earlier tax return to recover the tax paid on those capital gains.

Verifying and using your capital loss carryover

If you anticipate realizing on capital gains in the current year and have unused capital losses from past years, you may make use of that loss carryover now. You can find your carryover balance on your latest Notice of Assessment, or by logging into your My Account on the Canada Revenue Agency website, and viewing “Carryover amounts” under the “Tax returns” tab.

Candidate securities for ‘tax loss harvesting’

Look at your current non-registered account holdings to see if you have any securities in a loss position. You can sell a portion of those to realize sufficient capital losses to offset some or all of the capital gains in the current year, with the option to carry any excess back to any of the three preceding years. Depending on investor circumstances, a capital gain may be anticipated in a near future year, in which case there is the option to trigger a current loss to be applied against the future capital gain (assuming it comes about) in that later year.

To be clear, the tax impact contributes into your decision, but should not dictate your portfolio actions.

It may be the case that the currently-held securities still fit an investor’s longer term portfolio goals despite being in a loss position at present. After the securities are sold, the investor may be concerned about missing out on a price recovery of those disposed securities, which may make it may be tempting to immediately re-establish the position after triggering a capital loss. However, if the investor acts too quickly, there is a risk of being caught by the superficial loss rules in the Income Tax Act (ITA).

Superficial loss rules

These rules apply if the same security is purchased in the 30 days before or 30 days after the loss transaction. This extends beyond the investor personally to affiliated persons, including a spouse and registered plans belonging to either of them, such as a RRSP, RRIF, TFSA, RESP or RDSP. It may also apply to corporations or trusts of which either is a significant shareholder or beneficiary, respectively.

The mechanics of the rule is that the capital loss is denied on the sale transaction, but an equivalent amount is added to the adjusted cost base (ACB) of the new holding on the purchase side. Thus, the capital loss is embedded into the new holding and remains available for the holder to use in future, but cannot be used against capital gains arising presently.

An important exception to the application of the ACB addition on the purchase transaction is where a registered account is involved. The first half of the superficial loss mechanics will still apply to deny the capital loss, but there will be no corresponding addition to the ACB in the registered account. The capital loss is effectively permanently lost. This is true whether there are two distinct transactions, or where there is an in-kind transfer of securities from a non-registered account into a registered account.

Importing losses of a spouse

There is a way to use the superficial loss rules to strategically transfer a loss from one spouse to the other. Let’s say you have capital gains, while your spouse has unrelated securities in a loss position.

• • Your spouse sells and realizes a capital loss, and you purchase the same security in the +30/-30 day window.
  • Your ACB will be higher than your purchase price by the amount of the added loss denied to your spouse.
  • After waiting at least 30 days following your spouse’s settlement date (which is 2 days after the transaction date), you can sell to realize your loss, and use it against current capital gains in the usual manner.

Of course, the price of your new securities could rise during your holding period, reducing your expected loss. But that means you receive more money when you sell, so there’s not much to complain about under that scenario.

Settling transactions before year-end

The relevant date for capital gain or capital loss recognition is the settlement date. Beginning in 1995, the settlement day was three days following the trade date. It was reduced to two days in 2017, and as of May 27, 2024, Canada moves to one-day settlement, or T+1. For 2024 recognition, a sale on Monday, December 30 will settle the following day, Tuesday, December 31, the last business day of the year.