Tax Loss Selling
WEDNESDAY, NOVEMBER 2, 2022
As we approach the end of the year, investors should consider whether it makes sense to sell stocks at a loss and then use the loss to save tax otherwise payable. With the stock market down as much as it is this year, unrealized losses are plentiful and it may make sense to recover taxes paid from gains in the previous three years. Different considerations apply depending on whether you sell the stock personally or inside your corporation.
Personal tax loss selling
It’s almost always smart for individuals to create personal losses provided the decision makes sense from an investment perspective. Any losses realized will be used first to offset current year gains, with the remainder available to carry back to any of the three preceding years.
Two items to watch out for are:
1. Selling your position in a stock and then repurchasing: there are “stop loss” rules that prevent you from realizing a capital loss if you repurchase the stock within 30 days of the trade date. These rules come into play if you, your wife, or another “affiliated” person buys the same stock either 30 days before or after selling it. A common strategy is to sell the stock and buy back a similar but different position – for example, selling TD Bank and purchasing Royal Bank.
2. Selling the losing stock to your RRSP or other Registered Investments: when you transfer the stock to your RRSP or TFSA, any capital losses are denied. This is the exact opposite of when you transfer stocks at a capital gain to your RRSP or TFSA whereby you do have to take the capital gain into income.
Corporate tax loss selling
The core advantage of realizing capital losses to utilize in the current or 3 preceding years is the same for corporations and individuals. However, the tax rules relating to corporate income with refundable taxes and capital dividend accounts adds significant complexity. Whether this is a good tax strategy is very fact driven and probably requires discussion with your tax advisor. There are two key items to consider:
1. Do you need to withdraw money from your corporation in the next few years? If you do, then remember that capital gains are your friend from a tax perspective! Capital gains generate less than 30% tax even after accounting for the personal level of tax arising from withdrawing all the gain proceeds to an individual in the top tax bracket. This compares favourably to all other forms of withdrawing cash from your corporation.
2. How large will the refund be? When you pay tax on investment income inside a corporation, the corporation automatically gets a refund for a portion of this tax when it pays you a dividend. This means the tax loss refund may not be as large as you think. On a capital gain your corporation pays 25% tax. When your corporation pays you a dividend, the corporation gets a refund of 15% of this tax back. So, if you plan on carrying back the loss to a year your corporation paid you a dividend, the potential maximum refund you may get is only 10%.
The bottom line is that if you’re an investor who has a holding company with minimal shareholder draws and is built for the future, then realizing losses can make good sense. On the other hand, if your holding company is used to create personal cash flow and most income is used to pay out to shareholders then the tax loss selling might backfire.
If you decide to do tax loss selling make sure you keep the settlement date in mind. In order for the trade to be included on your 2022 tax return the settlement must happen in 2022 which is two days after the day you place the trade. This means you have to place the trade no later than Wednesday, December 28th to have the trade included in your 2022 tax return.
If you have any questions please call your RMT representative.