In the noisy buildup to the annual Christmas celebrations, it is often difficult to hear about anything over the drone of Christmas carols. But, if one listens carefully, one may hear the phrase “tax loss selling” uttered by your tax experts. This activity has nothing to do with Christmas – but if you do it right, tax loss selling can lead to the gift of lower taxes.
What Have You Realized?
When considering tax loss selling, it is important to understand the difference between realized and unrealized gains or losses. When you buy an investment, the initial cost is normally considered your “book value.” As time goes by, the market value of your investment will change to be either higher or lower than your book value. If you are fortunate enough to have the market value become higher than your book value, you end up with an unrealized gain. If it’s lower, you have an unrealized loss.
None of this normally makes any difference to your taxes unless you sell part or all your investment. This is called realizing a gain or loss – and it’s what causes tax implications. If you have a realized loss in an account that is liable for taxes, you can usually net that realized loss against other realized gains so as to reduce the amount of tax payable.
Why Do Tax Loss Selling around Christmas?
It is a coincidence that tax loss selling occurs in the Christmas season. The reason this happens is most people have tax year-ends at December 31. Any tax loss selling that you do must be completed by the end of the year to be included in your tax calculation for that year. You must also remember that because of holidays and the two-business day lag between the trade date and settlement date for any purchase or sale, you must make sure you make your sales well before New Year’s Eve.
A feature of tax loss selling is you do not have to apply your realized loss against realized gains in the year you make the sale. You can “carry back” your loss three years and net it against realized gains in those prior years. Or, you can “save” your loss and apply it against realized gains in future years.
Don’t Be Superficial
The tax gods do not want people to sell investments to realize a loss and then immediately buy them back. If you sell an investment to realize a loss, and you purchase an “identical security” within 30 calendar days before or after your sale date, and you still own the investment 30 calendar days after your sale date, then the capital loss is considered “superficial” and is denied to you for the purposes of tax loss selling.
There is some complexity to how this rule is applied so it is wise to be careful about buying the investment you are using for tax loss selling at around the same time as you are selling. This may also apply to buyers related to you, such as a spouse or your own corporation.
Look Beyond Taxes
No one likes to pay taxes, but it is important to keep a broad perspective when considering tax loss selling. By definition, the market value of your investment is likely lower than your purchase price. Is this really a good time to sell? If its price rebounds, you will miss out because you sold. In addition, you are not the first person to consider tax loss selling. There are often many other sellers in December, which tends to push prices down even more.
Since the actual Income Tax Act weighs more than your Christmas turkey, it is beyond the scope of this general article to give you specific tax advice.
You should always consult an expert before engaging in activities that affect your taxes.
But if you do this properly, the tax savings you create will be a nice Christmas present.
