As we move towards the end of the year, its time to remind people about some tax strategies they can employ before December 31st. In our year-end planning with clients, we review the available tax options available to mitigate their tax liabilities for 2021. These conversations happen in the Fall and are followed up before year end. Simple ones include contributions to their Registered Retirement Savings Plans (RRSP), Tax Free Savings Account (TFSA), and charitable donations. One less observed is the concept of tax-loss selling, the subject of our discussion today.
Despite the pandemic, 2021 was actually a good year for diversified investors. As the year enters its final month, the Canadian benchmark TSX Composite Index has increased in value by approximately 18 percent, narrowly trailing the U.S. benchmark S&P 500’s 20 percent rally. But being diversified likely means not every investment did well. If you have some dogs that don’t have a bright 2022, don’t fret. There’s a way to turn those capital losses into tax gains provided they are sold before the end of the year.
It’s called tax-loss selling and the resulting tax savings can be used to reap further tax savings in the new year.
What is tax-loss selling?
Tax-loss selling permits capital losses from equity investments to be applied against taxes paid on capital gains as far back as three years, or into the future indefinitely. Because half of capital gains in a non-registered trading account are taxed, half of capital losses can eliminate the taxes on capital gains dollar-for-dollar.
It’s important to note that tax-loss selling or tax on capital gains do not apply to investments in registered accounts including a RRSP or a TFSA.
How can it lead to tax savings?
The tax savings from tax-loss selling can generate additional tax savings by shifting the proceeds from a non-registered account to registered accounts in the new year. Here’s how:
While half of capital gains are taxed in a non-registered account, the tax on capital gains in a TFSA is zero. Capital gains in an RRSP are fully taxed when withdrawn in retirement along with income and original contributions, but investors are permitted to deduct their contributions from their taxable income.
RRSP contributions made before March 1, 2022 can be deducted from 2021 income or carried forward to future years when your tax burden is heavier.
Take note, however, there are specific rules set out by the CRA for tax-loss selling and contributing to registered accounts which must be followed.
- Superficial Loss Rule
This rule prohibits the repurchase of the same stock within thirty days of the tax-loss sale. The superficial loss rule applies to repurchases in any registered or non-registered account in the name of the account holder, and even the account holder’s spouse. If you want to repurchase the same stock, you must wait at least 31 days from the sale.
- Allowable Contribution Space
Also, if you are going to transfer the proceeds from a tax-loss sale to a registered account you must ensure you have contribution room.
The government has allowed a further $6,000 to be contributed to TFSAs in the new year, the total allowable space since it was introduced in 2009 will be $81,500. The contribution limit for RRSPs for 2021 is 18 percent of the previous year’s earned income up to a maximum of $27,830. Unused RRSP space from past years can be carried forward to 2021 or future years.
Check with the CRA on where your personal limits stand. Over-contributing to either could result in a penalty.
- Three-day settlement period
Finally, in order to take advantage of a tax-loss sale it must be settled by December 31st. Most trades take three business days to settle; which means Wednesday, Dec. 29 is the last day for Canadian and U.S. stocks.
The bottomline
The use of tax strategies in financial life planning is a specific planning tool that mitigates and lowers the overall tax amount paid. Of course, its prudent to be compliant but also to avail yourself of all the available tax options provided under tax legislation. Some such as RRSP and TFSA contributions are used regularly and are understood by most people. However, a discussion with your financial life planner and your accountant, may lead to some tax savings or deferral you may not be aware of. Being prudent and aware are key qualities in Keeping Life Current.
