Tax-Loss Selling: Opportunities when you have unrealized capital losses in your portfolio

Originally published IGPrivateWealth.com • November, 2023 

An investment portfolio review to identify tax planning opportunities before the end of the year is always a wise decision. In this article, we’ll discuss the concept of tax loss selling, how it works and how to ensure losses you trigger can be claimed as intended.

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How does “Tax Loss Selling” work?

Tax loss selling today can be used to free up additional cashflow when you file this year’s taxes next spring. If you recognize capital losses on your non-registered investments this year, they would first be used to reduce taxes by offsetting any capital gains realized in the same year. If this year’s capital losses exceed capital gains also recognized this year, the losses can be carried back to offset net capital gains reported in any of the last 3 taxation years. This may generate a tax refund for those prior years when net capital gains were reported. Keep in mind that this means that if you paid taxes on any net capital gains realized in 2020, realizing net capital losses in 2023 is your last chance to recover some of those taxes.

Capital losses that cannot be applied to capital gains in the current year, or the previous 3 taxation years, can be carried forward into the future indefinitely.  This said, if the capital losses cannot be claimed against capital gains anticipated this year or through a loss carry back strategy, then generally there will be no tax reason for realizing such losses today.

Even in less turbulent times you don’t want to miss a positive trading day in the markets. However, there are complex tax rules that can potentially deny the capital loss you may plan to realize. So, you need a plan to stay invested with the same risk tolerance whilst at the same time preserving the use of your loss.

Watch out for “Superficial loss rules”

Superficial loss rules are intended to prevent you from realizing and claiming a capital loss for tax purposes when your actual intent is not to sell the property. These rules deny some (or all) of the loss for tax purposes where certain conditions are met.

The superficial loss rules apply if:

• during the period that begins 30 days before a disposition and ends 30 days after the disposition, you or a “person affiliated” with you, acquires a property (referred to as the “substituted property”) that is the same property or “identical property”, and
• at the end of that period, you or a person affiliated with you owns or had a right to acquire the substituted property
  
  

Double taxation is prevented by adding the amount of the superficial loss to the adjusted cost base of the substituted property, placing you in the same tax position relative to the substituted property as was the case prior to the transactions. As such, no tax advantage is gained, but no tax disadvantage either.

What are Identical Properties?

At the heart of the superficial loss rules is the definition of an “identical property”. Identical properties are properties that are the same in all material respects, so that a prospective buyer would not prefer one over another.

Who is an Affiliated Person?

A loss will fall within the definition of a superficial loss even if the substituted property is not acquired by you, but rather by an “affiliated person”. The definition of affiliated person is quite broad and includes the following relationships:

• you and your spouse or common-law partner
• you and a corporation or partnership controlled by you, your spouse or common law partner
• a trust and its majority interest beneficiary or their spouse
  
  

Here’s an example of how superficial loss rules work:

• On January 31, 2023, an investor purchased 100 shares of XYZ Inc. for $100 per share
• The shares declined in value and on May 1, 2023, the investor sold all the shares for $70 per share
• The investor repurchased 100 of the same shares of XYZ Inc. two days after the sale at $70 per share
• Superficial loss rules will deny the capital loss and add the $30 loss per share to the newly purchased shares of XYZ Inc.
• As such, the shares of XYZ Inc. purchased on May 3, 2023, have an adjusted cost base (ACB) of $100 per share, not $70 per share
• The investor then sells the 100 XYZ Inc. shares on July 2, 2024 for good for $120 per share, realizing a capital gain of $2,000, or $20 per share

In this example, the investor did not wait the required 30 days before repurchasing the same shares – therefore the superficial loss rules apply. As a result, the capital loss triggered on May 1, 2023 of $3,000 is denied and added to the ACB of the shares of XYZ Inc. reacquired on May 3, 2022. When the investor subsequently sells the shares of XYZ Inc. in July 2024, the capital gain realized will be based on the same ACB as it would have been had the investor never sold the original shares back in May of 2023. 

Tax loss selling is complicated and if you’re considering this approach, understanding the potential tax implications is critical. Consult with your accountant to understand how such losses can work for you and to ensure losses you do trigger can be claimed as intended. To begin the discussion, contact the team of financial consultants at Jeff Somers & Associates to help determine whether a tax loss selling strategy could work for you.