Tax loss selling remains powerful tool

Generally speaking, if a client is in a long-term investment plan, selling and crystallizing losses at the bottom of a market cycle is not ideal unless the client tends to reinvest the money in accordance with their long-term investment goals.

Superficial tax loss rules prohibit investors from selling and reinvesting for 30 days after the initial sale. If clients are not satisfied with an alternative security, they run the risk of missing out on short-term gains while they wait on the sidelines.

With markets plummeting uncharted depths, advisors were fairly certain they could crystallize tax losses, wait the mandatory 30 days to repurchase the securities and still be well below the previous highs experienced by the investor.

This year is not as straightforward. Many portfolios are still on the decline but the market is amidst one of the fiercest comebacks in history. Missing a month out of the market can result in missing substantial returns.

“Ultimately, I would say your decision to buy or sell securities is more of an investment decision than a tax decision. It should be more of an investment decision,” says Gena Katz, executive director at Ernst and Young LLP. “[If you’re going to sell] remember the last day of trading is December 24 for Canadian exchanges and December 28 for U.S. exchanges because they don’t have Boxing Day.”

Katz says one of the hard decisions for clients this year is if they want to sell securities that are in a gain position and use carry-over capital losses from last year to reduce taxes on that gain on this year’s tax return.

“In fact, this may be a tax gain selling year for a lot of investors who sold for losses at the end of last year, got back in the market and made some significant gains,” Gena Katz. “There is no such thing as a superficial gain. If you sell for gain, you can re-buy the security if you care to the very next day. That’s not an issue but you are paying some transaction fees. If in fact you’re waiting, you have real economic risk, you don’t know what the market is doing in the interim.”

Carol Bezaire, vice president of Tax and Estate planning at Mackenzie Investments points out that that switching between mutual fund trust and mutual fund corporations is not subject to superficial trading rules.

We always talk to advisors about keeping clients invested even though you harvest losses. You can move from a corporate structure mutual fund to a trust fund at the same time or vice versa. That keeps the client invested [in essentially the same mandate],” she says. “For example, at our firm they can go from Cundill Value fund to Cundill Value class.

She adds, “The tax on the two structures is totally different. It’s considered a whole new mutual fund, so the superficial loss doesn’t apply.”

Bezaire says this year may be one of the last opportunities to find significant losses in long-term portfolios that can be harvested to offset future gains. In the work she does with advisors, she says it’s a hot topic.

“What advisors are using the discussion about tax-loss planning as an opportunity to have your client come in and take a look at where we are right now. It’s an opportunity change up the portfolio or look for new business. Capital loss selling is still a topic of conversations,” she says.

For example, losses can be harvested for use in estate planning to offset potentially large gains that occur during the deemed disposition of a client’s portfolio at death.

“Elderly clients may want to start looking at the overall capital gains or losses situations and change things up a little bit,” she says. “In their long-term portfolio, there are lot of embedded capital gains and deemed disposition at death for instance. You may want to start harvesting some losses and gains so that they remain in a middle tax situation. You can use this opportunity to change up their portfolio a little bit.”