You decided to invest in a business.
A promising and well managed publicly traded company with exciting growth potential.
Somebody advised you that the ride to profitability would not be linear. A total loss of capital was the risk trade-off. After all, no one ever intentionally tries to lose money, so you diversify your holdings to minimize such risk factors.
Fast forward to November 2022. Stocks, bonds, gold and Bitcoin are all down. So now what? Besides sticking to your positions, are there tax advantages you should consider before December 31st?
Investing for profit is typically the ultimate goal. But if you find yourself today with unrealized losses, meaning your investments trade lower than what you paid for, tax loss harvesting might be worth your consideration.
What is Tax Loss Harvesting?
Tax loss harvesting is an investing strategy where you sell your investments at a loss to generate a capital loss. These transactions happen outside your TFSA and RRSP accounts, typically called your cash or non-registered accounts.
How does it work?
You can use your realized loss in 3 ways:
- Offset losses with gains in the same year.
- Offset gains made in the last 3 years with losses triggered this year.
- Offset future gains indefinitely with losses triggered this year.
Tax loss harvesting involves selling your investments at a loss and simultaneously selling your profits. This is done to realize the taxable gain either 3 years back, current year or in the future indefinitely. The result is that you only pay taxes on your net profit. Your net profit is the difference between your gains and losses.
It is important to remember that tax loss harvesting happens outside of your RRSP.
There are no tax advantages from a tax loss harvesting perspective with RRSPs and TFSAs. That’s because with RRSPs, all transactions have tax deferrals until withdrawal. When an investor converts their RRSP to a RRIF, any withdrawals made will be considered ordinary income. As for TFSAs, all transactions are tax free so no need to apply a tax loss harvesting strategy.
When should you considering using a tax loss harvesting strategy?
The best way to maximize a tax loss harvesting strategy is to sell positions that you’re willing to buy back after 30 days. This is because for the capital loss to qualify from a Canadian Revenue Agency (CRA) tax rule perspective, investors will need to wait 30 days before buying back the same security; this tax rule is called a superficial loss.
You could even sell your stocks at losses and time the transactions with the sale of your cottage. Is it likely your cottage has a significant amount of deferred value and selling your stocks at the same time may be to your financial advantage.
To learn more about this example check out my interview with the Globe and Mail.
What is the January Effect?
The January effect is a perceived seasonal increase in stock prices that can take place during the month of January. Analysts and investors alike attribute market rallies that when, taking place in January, are a signal of tax loss harvesting reversing its course. Another contributor to this theory is the involvement of year-end bonuses which employers pay out the following month and therefore provides January with more liquidity for stock purchases.
What is this week’s takeaway?
Watching your investments drop in value is certainly a stress test and can make even experienced investors question their previous investment decisions.
Price discovery is a form of volatility and can happen anytime, December included. When it comes to tactical moves like tax loss harvesting, investors can find comfort in knowing logical reasons could exist behind recent price dips in stocks.
In my opinion, losses, unrealized or not, does not need to be an eye sore but rather viewed as a tool to increase your net after tax growth rate.
If you can apply this type of mindset to your investment strategy, you may just find yourself recording even more wins for yourself.
Have a great weekend and Happy Thanksgiving to all of our U.S. relationships!
Talk soon,
Michael
Disclaimer:
This publication contains the opinion of the writer. The information contained herein was obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made by the writer, Mandeville or any other person as to its accuracy, completeness or correctness. The information is for informational purposes only and is not intended to constitute investment, financial, legal, tax or accounting advice. Many factors unknown to us may affect the applicability of any statement or comment made in this publication to your particular circumstances. Hence, you should not rely on the information in this publication for investment, financial, legal tax or accounting advice. You should consult your financial advisor or other professionals before acting on any information in this communication.
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