Deck the Halls with Dollars! How Tax Loss Harvesting Works

Deck the Halls with Dollars! How Tax Loss Harvesting Works

And How You Can Make Your December Merry By Unlocking the Power of Tax Loss Selling

For the typical Canadian investor, the concept of tax-loss harvesting may initially appear intricate, yet its implementation can be rather straightforward, contingent upon adherence to a set of guidelines. Effectively, a well-structured tax-loss harvesting strategy has the potential to yield substantial tax savings over an extended period.

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How Does Tax Loss Selling Work?

Tax-loss selling, also known as tax-loss harvesting, is a strategy employed by investors to offset capital gains and minimize tax liabilities. Here’s a step-by-step explanation of how tax-loss selling works:

  1. Identification of Losses: Investors review their investment portfolio to identify securities (stocks, mutual funds, ETFs, etc.) that have decreased in value since their purchase.
  2. Sell Securities at a Loss: The investor decides to sell the underperforming securities at a loss. This sale triggers a capital loss.
  3. Offsetting Gains: The capital loss realized through the sale is then used to offset capital gains that the investor may have incurred elsewhere in their portfolio. This can help reduce the overall tax liability. This strategy is particularly effective when applied to holdings with exceptionally low Adjusted Cost Bases (ACBs) that hold a significant position in the portfolio. Selling the underperforming asset alongside a portion of a substantial gainer allows for a strategic rebalancing of the portfolio, which can help optimize the allocation for better overall performance.
  4. Tax Savings: By strategically selling investments at a loss and using those losses to offset gains, investors can lower their taxable income for the year. This, in turn, reduces the amount of taxes owed to the government.
  5. 30-Day Wash Rule: Investors need to be mindful of the “30-day wash rule,” which stipulates that if they sell a security for a loss, they cannot purchase the same or substantially identical security within 30 days before or after the sale. Violating this rule may result in the disallowance of the capital loss for tax purposes.
  6. Reinvestment: After selling the underperforming securities, investors may choose to reinvest the funds in a similar but not substantially identical investment. This allows them to remain exposed to the market while adhering to the 30-day wash rule.

It’s important to note that tax-loss selling is primarily applicable to taxable, non-registered investment accounts. Investments held within tax-advantaged accounts like RRSPs and TFSAs are not subject to capital gains taxes, so the strategy is typically not applicable in these accounts. Additionally, investors should consult with a tax professional to ensure compliance with tax regulations and to optimize the effectiveness of their tax-loss harvesting strategy.

Can You Give Me an Example?

Sure In the context of illustrating tax-loss harvesting within an ETF portfolio, consider a hypothetical scenario (for illustrative purposes only):

Initially, a sum of $25,000 was invested in an Index ETF back ABC in 2019. However, the current value has experienced a decline to $20,000 or a loss of $5000. Given that these funds are held in a non-registered account, the decision is made to sell ABC and subsequently reinvest $20,000 into another ETF called XYZ. Although XYZ tracks a different index, its holdings exhibit similarities.

By recognizing the capital loss from ABC, you gain the ability to employ tax-loss harvesting, allowing for a deduction of up to $5,000 against potential future capital gains on the second index. The similarity between the two funds enables the anticipation of comparable returns over an extended period.

Now, let’s consider a scenario where you currently hold another ETF, GHI, and have experienced substantial gains in this investment. Purchased 8 years ago for $25,000, it has now appreciated to a value of $80,000. Recognizing the need to lessen the concentration of this holding within your portfolio, you can strategically apply the $5,000 loss from the previous investment to offset a reduction in the GHI holding. By precisely calculating the amount needed to sell from GHI to realize a $5,000 gain, you can effectively manage the weighting of your portfolio and align it with your diversification goals.

In this specific case, to achieve a $5,000 gain on GHI, you would need to sell $7,272.72 worth of GHI shares. By doing so, you effectively reduce your exposure to GHI to $72,727.27 and generate $27,272.72 in cash that can be strategically deployed elsewhere in your portfolio. This is a common scenario that arises in my practice, where investors grapple with one or two positions that have experienced significant growth and are seeking to reallocate their portfolio to maintain a more balanced and reasonable weighting.

The Pros Of Tax Loss Harvesting…

When managing capital gains and losses within your taxable investment accounts, numerous factors warrant consideration. To assist, here’s a concise list outlining the advantages of tax-loss selling:

  • Reduce taxes in non-registered investment accounts
  • Minimize the adverse effects of losses within your portfolio
  • Integrate with portfolio rebalancing to enhance your asset mix
  • Strategically save on taxes in future years

If you’re looking to employ this approach, it is advisable to seek guidance from a tax professional before implementing your own tax-loss harvesting strategy.

The Botton Line….

Canadian investors enjoy a wealth of tax-sheltered investment options, such as RRSPs, RESPs, and TFSAs. The most effective method to minimize taxes on your investments involves optimizing your contribution room in these registered accounts. Once you’ve maximized those contributions, tax-loss harvesting emerges as a valuable strategy to uncover additional tax savings within a taxable account. It’s essential, however, not to incur capital losses indiscriminately. Instead, seek opportunities to rebalance high-fee investments that have experienced a decline in value, and exercise caution to avoid superficial losses.

In the presence of capital gains from the current or preceding years, it is advisable to prioritize the utilization of capital losses to offset them initially. Additionally, if you opt to undertake your own tax-loss harvesting, it is crucial to consult with a tax professional beforehand to ensure a well-informed and strategically sound approach.

Have Questions? Contact us!

We’ve assisted our clients through every stage of life. Even when you’re not aware that something might impact your financial future, it likely will to some extent. Engaging in a conversation with your investment advisor about any financial changes is an excellent approach to keeping your financial goals in focus.

We have expertise in cross-border wealth management. Don’t hesitate to reach out to us — we’re committed to providing tailored solutions for your cross-border financial needs.

For more information or to connect with me, you can reach out via email at macekadmin@iaprivatewealth.ca or get to know me better by exploring my engaging video content on YouTube https://www.youtube.com/@joemacek.

I share valuable insights and discussions on financial planning, market commentary, and investing concepts that can further enrich your understanding. Join me on my channel to discover more!

Don’t hesitate to reach out today at 1–888–324–4259 to discover more about how we can help you achieve your investment milestones.

Joe A. Macek, FMA, CIM, DMS, FCSI

Investment Advisor, Portfolio Manager

iA Private Wealth | iA Private Wealth USA

Toll Free North America: 1–888–324–4259

Email: macekadmin@iaprivatewealth.ca

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