The recent drop in oil prices has many investors on edge, especially in Canada. Since oil started dropping in July, the TSX Index has declined by about 9.51%, virtually eliminating gains for 2014, while the energy index is down about 40.65%. But did you know you can potentially use these losses, especially oil stocks, to your advantage?
Tax-loss selling is a powerful tool that can improve returns by reducing taxes in non-registered accounts. Here’s how it works: if you sold an investment with a realized capital gain in this year or any of the previous three years, and you currently hold unrealized losses, you might consider realizing some of these losses to offset the gain. That way, you can strategically balance your losses against your gains to reduce the amount of potential tax owed. If you have losses from prior eligible years, you may be able to use those as well to offset any gains in the current tax year.
Important point: When tax-loss selling, you must ensure the selling transaction is fully settled before the last business day of the year. That means the last day to execute tax-loss selling transactions in Canada this year is December 24, 2014. For US investments, the date is December 26, 2014.
But what happens if you think the stock will eventually go back up?
You can repurchase the security at a later date, but you’ll want to pay attention to the “superficial loss rule”. The rule says to claim the tax-loss, you cannot repurchase an “identical investment” within 30 days after the sale. The same goes for your spouse, corporation, trust or any other account where you have a beneficial interest including RSPs. Shares of competing companies in the same industry are not considered “identical”, however mutual funds or exchange traded funds which track the same index are considered “identical”.
Different investment strategies can make use of tax-loss selling in different ways. For example, index, buy and hold, or passive investors might incorporate it into their year-end rebalancing plans. In the Growth and Income Portfolios we regularly make use of tax-loss selling throughout the year by trimming losses as they happen.
Like any tax and investment strategy, seek professional advice before starting.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.