2021 was 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 per cent, narrowly trailing the U.S. benchmark S&P 500’s 20-per-cent 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 registered retirement saving plan (RRSP) or a tax-free savings account (TFSA).
HOW CAN IT LEAD TO FURTHER 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 Capital gains in an RRSP are fully taxed when withdrawn in retirement along with income and original contributions, but investors are permitted to deduct their contributions from their taxable income.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 Canada Revenue Agency (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 per cent 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 Dec. 31. Most trades take three business days to settle; which means Wednesday, Dec. 29 is the last day for Canadian and U.S. stocks - so get cracking.