Tax-loss selling is the strategy of selling investment holdings that have decreased in value, and then using that loss to offset the taxation of capital gains in other areas of an investment portfolio.
Many investors strive to minimize their taxable gains, while seeking ways to effectively manage any losses that might have accrued over the year. Tax-loss selling is a technique that may help on both fronts.
“Buy low, sell high” may not apply when it comes to tax-loss selling
The idea of selling investment holdings that have decreased in value goes directly against the age-old adage that we have heard time and time again: “buy low, sell high.” For this reason, the act of “selling low” might evoke distress or uncertainty about whether you are making the right choice.
“Buy low, sell high” may generally be a good rule of thumb, but when tax-loss selling is executed properly, and for the right reasons—it can potentially help you to mitigate years of high tax within your portfolio, and also potentially help to rebalance your portfolio to remain aligned with your overall investment goals.
Why should I think about tax-loss selling now?
With the holiday season upon us, most of us are more focused on gift-giving and merrymaking (or, for some of us, avoiding our less-than-agreeable relatives at family gatherings) than thinking ahead to our taxes.
Tax-loss selling can be completed at any time of the year; however, with tax season just a few months away, many investors consider December an optimal time to focus on their investment portfolio’s performance.
Tax-loss selling considerations
Before proceeding with selling losses to offset gains, take these points into consideration:
- Have you crystalized (realized) gains that need to be offset this calendar year?
- If so, these are the capital gains you would offset first.
- Have you realized any capital gains over the past three years that have not yet been offset?
- You may use current-year net losses and apply them retroactively to a maximum of three years.
- Do you have any unused net capital losses from previous years?
- In Canada, losses can be carried forward indefinitely; if you have “old” losses, you can apply these before needing to sell newer holdings.
- Are your holdings non-registered (cash)?
- You cannot use losses/gains from registered accounts (RRSP, TFSA, LIRA, etc.)
Most importantly: Remember that your overall investment goals and your risk tolerance should take priority over potential tax advantages. Don’t lose sight of your personal investment goals for short term tax benefits.
Understanding potential tax-loss selling limitations
When considering tax-loss selling as a portfolio management technique, it is important to be aware of any specific limitations. For example, “superficial loss” rules will apply if you choose to sell securities. This rule looks at a 60-day time frame –30 days before the date of sale, and 30 days after—and will deny your ability to claim a loss if the security is repurchased (by yourself, or an affiliated individual) within those 60 days. This rule applies to both registered and non-registered accounts.
The bigger picture
Selling investment holdings (whether in a loss or gain position) can be a healthy part of managing your investment portfolio. When it comes to rebalancing your portfolio, or re-aligning your concentration within certain industries, sectors, or issuers, tax-loss selling may be a useful strategy.
Tax-loss selling may not be a technique that is used every year, or even by every investor, but it is a beneficial strategy to be aware of. Prudent portfolio management means frequently considering the bigger picture: your cashflow, retirement, and overall risk tolerance, and in some situations, selling in a loss position may help you better prepare for future financial milestones, and bring you closer to your investment goals.
As with any tax and portfolio management techniques, it’s important to work with qualified individuals. We recommend working with your tax advisor or accountant to help clarify and confirm any tax-related action you wish to take as it relates to your personal holdings.
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