We’ve faced rather lacklustre equity markets in North America relative to 2003, and some may wonder whether there is an opportunity in some of those paper losses showing up on investment statements.
Selling investments in stocks, mutual funds, exchange-traded funds and bonds that for one reason or another have underperformed, can be an important component of your year-end tax plan.
Converting paper losses in investments in stocks or mutual funds into cash losses is known as tax loss selling.
Canada Revenue Agency identifies the transaction as a capital loss. As such, the capital losses generated can be used to offset capital gains generated from the sale of successful investments.
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A tax or capital loss taken in 2004 can be used to offset capital gains incurred in 2004 or, if there aren’t sufficient gains, can be used against capital gains taken in the past three years.
As such, you can save on income taxes for this year or get a tax refund for any year going back to 2001 in which you have reported and paid tax on capital gains.
Capital losses can be carried forward indefinitely. By checking your 2003 notice of assessment, you can determine whether you have any unapplied capital losses that you are carrying forward.
The revenue agency should also be able to provide a record showing the history of gains reported and how you applied losses in prior years. This is applicable only to the non-registered investment component of your portfolio.
Some examples of fallen stocks for the tax year 2004 that you may want to consider as tax loss selling candidates are as follows:
Westjet Airlines: As of Nov. 24, the company’s stock price has lost 41.2 percent this year. Issues of corporate espionage, lower traffic and higher fuel costs have kept this airline’s stock price depressed.
CFM Corp.: As of Nov. 24, the company’s stock price has lost 77.4 percent this year. Continuous earnings warnings associated with higher steel costs and anti-dumping duties in its Asian outsourcing business have put this barbecue manufacturer’s stock in a downward spiral.
Once you have an idea of the investments you wish to sell, it’s important to note that the settlement date, not the trade date, is the effective date for selling purposes. Because of the three-day settlement rule, Dec. 24 is regarded as the last day on Canadian exchanges to take advantage of tax loss selling.
However, regardless of deadlines, it’s best to consider selling well before this period because you may get a higher price for your investment. If you wait and sell with the herd of other tax loss sellers close to the deadline, the security will likely be oversold. If you prefer to maintain a weighting in the security, this is the time to be buying.
Another important consideration is the liquidity of the stock. If you are invested in a stock that typically doesn’t see large volumes of trade, it may take more time to sell it. This increases the importance of putting that sell order in well before the Dec. 24 deadline.
It’s also important to be aware of what CRA determines to be a superficial loss. This is a situation where you sell stock to trigger a capital loss and then you, your spouse or a corporation that either of you controls, buys the same stock within 30 days before or after the sale of the investment. The federal agency regards this type of capital loss as superficial and it is ruled ineligible.
However, you can generate claimable losses and still keep your stock market exposure within this restricted period by considering alternative securities with a similar sector weighting. For example, if you owned a Canadian equity mutual fund that was a candidate for a capital loss, you could sell it and perhaps buy an exchange traded fund that replicates the S&P/TSX Composite or vice versa.
Finally, there is another form of capital loss that you may have faced in the past. Perhaps you owned shares in a company that has lost all its value through bankruptcy.
If the company is not carrying on business either directly or through a subsidiary, the agency allows you to take a deemed disposition at nil. That means the fair market value of the shares is zero and you can claim a capital loss based on your remaining adjusted cost base. But bear in mind that if during the following 24 months the company comes back to life, you must recognize a capital gain equal to the capital loss written off.
Ian Morrison is an investment adviser with Wood Gundy in Calgary and is licensed to sell insurance products. His views do not necessarily reflect those of CIBC World Markets Inc. or The Western Producer. This article is for information only. Morrison can be reached at 800-332-1407 or by e-mail at Ian.Morrison@cibc.ca.
