Financial Road Map

Tax-loss harvesting is a strategy used by investors to sell shares held in a non-registered account that have dropped in value – thus incurring a loss when sold – and then use this loss on their tax return to offset other capital gains incurred throughout that year. The loss can be carried forward indefinitely and can also be used on capital gains incurred in the last three calendar years.

The ideal is, of course, to buy stocks low and sell high, but if that’s not an option and selling is on the table, you can earn tax benefits by taking the loss now. But experts say that before investors jump into this strategy, they should be aware of rules, deadlines and criteria to ensure this is the right option for them.

“People are often quick to jump at the idea of selling something at a loss because they think that just having that capital loss in hand is going to help them. That’s not necessarily true,” Mr. Cestnick says.

First, identify whether a capital gain has been realized this year or the previous three years (which would have already been taxed). If that’s the case, then this might be a good time to reap the losses in order to offset or regain the tax to be paid (or previously paid) on these investments.

Then decide whether the stock is worth holding on to, Mr. Cestnick says. “In other words, do you still like it? If you don’t like the investment any more then that may be reason enough to sell.”

But there is always the possibility the investment has simply hit a rough patch and gains are just around the corner, so be sure selling is the right strategy.

The tax-loss harvesting process is fairly straightforward if it’s a straight-up sale and the owner has no desire to own the stock again. It can become more complex for people who are hoping their downtrodden stocks will eventually see an upswing, but still want to have the tax-loss harvesting benefits in the coming tax year, says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management.

“You may be tempted to sell the stock at a loss, realize the loss and then immediately buy it back again, and that way you’ve got the loss and you still own the stock,” he says, explaining that this is what’s called a “superficial loss.”

The Canada Revenue Agency’s Income Tax Act prohibits the immediate repurchase of these sold shares and will deny the tax loss if the same property is repurchased within 30 days. In fact, the 30-day buyback rule not only applies to the original investor, but those affiliated with him or her – a spouse, for example.

There are ways around the superficial loss regulation. Someone outside the family could purchase the stock on the investor’s behalf and hold it until after the waiting period, but it usually takes a financial expert to navigate that and it could be pricey.

“If you have a financial adviser, I would sit down with them and talk to them in the month of December and say, ‘Do you think there’s some opportunities for me for loss crystallization?’” says Mr. Golombek.

Transaction fees and costs should also be considered when determining whether tax-loss harvesting is the right choice, says Gordon Ross, portfolio manager at Index Wealth Management Inc. Investors may have to pay transaction fees to sell their shares – and the cost could go up, depending on the complexity of the transaction, Mr. Ross explains.

“Every investor needs to have just a rough awareness of what’s going on, because it’s easy for someone to sell you something by focusing on the tax benefits,” Mr. Ross says. For him, the investor should do the research, be familiar with the portfolio and make sure the tax benefit of tax-loss harvesting outweighs the time and money incurred in the process.

How do you know whether tax-loss harvesting is right for you?

Say you bought 1,000 shares of a technology company at $53 apiece. Today the value is $50 a share.

First, survey your portfolio and see whether you have made any capital gains this year or in the three previous years that you want to offset (for instance, gains on a stock you sold). Be aware of deadlines, however. The deadline to sell and have the losses count against next April’s tax filings is Dec. 24 (trade date), and settled by Dec. 31.

You can then sell the shares, take the $3,000 loss and use it to offset other gains.

If you want to reinvest in the stock, but still want the tax-loss selling benefit, here are additional elements to consider (experts advise consulting a financial adviser or your accountant to help keep you out of hot water):

Establish why you want to sell the stock in the first place and whether it’s more beneficial to hang on to it. If you think the stock will go up to $60 a share, it could be more advantageous to wait for those gains rather than to sell and incur the loss for the tax benefit.

If you decide to sell but still want to hold the stock in your portfolio, follow the “superficial loss” rules laid out in the Income Tax Act. Neither you nor anyone affiliated with you can repurchase the stock for 30 days after the sale.