Can you monetize a loss in an investment? It doesn’t seem logical at first glance, but the answer is yes. You may be able to save tax from this type of transaction. With stock markets in decline since the beginning of the year, it may even be to your advantage. However, there are a few things you should keep in mind to prevent this strategy from backfiring.
First of all, this strategy only works for non-registered investments, whether:
- mutual funds,
- exchange-traded funds.
The Canadian tax system allows the capital loss on the sale of this type of investment to be used to offset any capital gain realized during the taxation year. The capital loss can be carried back up to three tax years or carried forward indefinitely.
Pitfalls to avoid
However, investors who opt for this strategy need to be aware of the rules on superficial losses. These rules state that if an investor buys back the same or identical security within 30 days, the capital gain from the tax-loss sale will be denied. The rules prevent losses from being realized when there is no perceived change in ownership.
Let’s look at an example: An investor purchases 10 shares of ABC Bank Inc. at a price of $10 a share on February 1, 2022, for a total of $100. On September 1, 2022, the share value drops to $7. The investor decides to sell the shares and receives $70. However, the $30 capital loss must be reported on the investor’s 2022 tax return.
Our investor wants to remain active in the financial markets and likes the profile of ABC Bank Inc. On September 15, 2022, the investor puts the $70 into XYZ mutual fund, which holds this stock in its portfolio. By investing the $70, our investor owns 10 units of this fund at $7 per unit.
On October 1, 2022, the unit value increases to $9, while the share of ABC Bank Inc. rises back to 10$. The investment in XYZ mutual fund is therefore worth $90.
Considering this data, our investor has two options:
- The investor may decide to hold on to the units in the XYZ mutual fund, but still report the capital loss from selling the ABC Bank Inc. shares at a loss of $30.
- The other choice is to sell the units in XYZ mutual fund. That will generate a profit of $20. Part of the previous loss of $30 can then be used to offset this gain. The net loss of $10 can be carried back up to three previous taxation years to offset capital gains previously reported or it can be carried forward to offset future capital gains.
Get expert advice
This type of strategy can be complex and result in unintended or even negative consequences. Bearing this in mind, it’s best not to try to transfer a non-registered investment with an accrued loss in-kind to your RRSP or TFSA, otherwise the capital loss will be denied. There are also harsh penalties for “swapping” an investment from a non-registered account to a registered account for cash or other consideration.
To make sure you understand the ins and outs of this strategy, it's a good idea to work with a qualified tax specialist.
Information contained in this article is for information purposes only. It is not intended to provide or be a substitute for professional financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard. It also does not constitute a specific offer to buy and/or sell securities. You should always consult your advisor or tax specialist before undertaking any of the strategies contained in this article to ensure that all elements your personal circumstances are taken into consideration in developing your individual financial plan. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy and SLGI Asset Management Inc. disclaims any responsibility for any loss that may arise as a result of the use of strategies discussed.
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