Tax-loss harvesting

Tax-loss harvesting is a strategy that lets investors use capital losses to offset capital gains.

Doing this reduces the taxes you owe on your gains, and in some cases can cancel them out completely.

Why consider tax-loss harvesting?

• You want to offset the current year’s taxable capital gains
• You’re interested in carrying back losses to offset gains from the previous 3 tax years
• You’d like to carry forward losses indefinitely to offset gains in future years
  

Most importantly, to maximize your end-of-year (and future) portfolio performance, remember to consider the impacts of tax-loss harvesting alongside portfolio rebalancing and diversification.

The end of the calendar year is a great time to reassess and realign your investment priorities for your portfolio. This is because capital gains and losses need to be finalized before the end of the year, accounting for T+1 settlement. We’ll cover this in more detail later on in this article.

Learn more about rebalancing, and how it can work for you.

Eligible accounts

Tax-loss harvesting is only relevant in taxable, non-registered accounts like a Questrade Cash or Margin account.

Registered accounts like a TFSA, RRSP, FHSA or RESP don’t qualify since these accounts are already tax-advantaged.

Offsetting gains and losses

When you incur a capital gain in a taxable account, a portion is added to your taxable income at the capital gain inclusion rate. However, capital losses can be used to reduce these taxable gains.

Imagine a scale where your gains are on one side and losses on the other. By strategically using losses, you can reduce or even negate taxable gains, lowering your overall tax liability.

In Canada, only part of a capital gain is taxable, which is known as the capital gains inclusion rate. This inclusion rate is applied on realized gains, so no matter how long you hold an unrealized gain (or loss) on an investment, and how much it grows, it will only count towards your taxable income once it's sold.

Remember: You also cannot deduct more losses than you have gains. For example, capital losses in excess of your capital gains cannot reduce taxes on your employment income.

As of June 25, 2024, capital gains inclusion rates for individuals are:

• Gains up to $250,000 annually are taxed at the 50% inclusion rate.
• Gains exceeding the $250,000 threshold are taxed at a two-thirds (66.67%) inclusion rate.

Let’s take a look at a few examples of tax-loss harvesting, and how it can help optimize your year-end planning to reduce the amount you would owe.

Example 1: Using tax-loss harvesting to offset gains in the same tax year

Let’s say you’ve had a pretty good year for investments, and you’ve realized $20,000 in gains from some tech stocks you sold recently. With this $20,000 gain, right now you’re looking at an additional $10,000 (50%) being added to your taxable income (assuming you have no other realized gains).

If you also have some losing positions in your portfolio that you don’t plan on keeping and no longer have long-term conviction in, this could be a great time to reduce that gain from earlier by balancing it out with a capital loss.

If for example you also had some energy stocks that haven't performed well this year, let's say you bought them for $10,000 and their current fair market value is $6,000, you could sell them and apply the $4,000 loss against your gain from earlier.

This brings your total $20,000 capital gain down to $16,000, and the addition to your taxable income is reduced to only $8,000.

Example 2: Carrying losses backward to offset last year’s gains

Consider an example where you unfortunately have $10,000 in realized capital losses this year, but don’t have any capital gains to offset. This $10,000 loss can’t be used to reduce your employment or other income, so you have two options:

• Carry it forward indefinitely to use against capital gains in future tax years; or
• Apply it to net capital gains in one of the previous 3 tax years.

Let’s say you had some really great gains last year, and that added $20,000 to your income on which you had to pay tax. If we apply this year's $10,000 capital loss against your net capital gain from last year, you'd be owed an adjustment and a refund of prior taxes paid.

This strategy helps turn current losses into a potential tax benefit, whether it's for any of the last 3 years, or to keep and use in the future.

Example 3: Tax-loss harvesting with the higher inclusion rate

Let’s take a look at a third example, one where the higher 2/3rds (66.67%) inclusion rate applies to gains above $250,000.

Since capital gains tax also applies to other types of investments like real estate that is not your principal residence, we'll use a realistic example with different investment types.

Let's say you sold the family cottage this year since it was getting too expensive to maintain, and assuming the principal residence exemption doesn't apply, you're looking at a capital gain of $350,000. You also had a great year for investments, and sold some ETFs for an additional gain of $50,000 for a total capital gain from all sources of $400,000 for the year.

With the higher inclusion rate, you’re looking at $125,000 in taxable income from the first $250,000 (50% inclusion rate), and approximately $100,000 in taxable income from the remaining $150,000 (66.67% inclusion rate). This would increase your total taxable income by $225,000, which would mean a considerably large tax bill.

If in this example, you also had some capital losses you were able to realize, this could significantly lower your taxes owed given that you have capital gains included at the high inclusion rate.

Let's say you also had some stocks that haven't performed as well over the past few years, and you're looking at exiting those positions. You sell these stocks for a total capital loss of $80,000.

If you subtract this $80,000 loss from our $400,000 gains from earlier, this brings the net capital gain down to $320,000. Your taxable income in this case would be $125,000 from the first $250,000 (50% inclusion rate), and approximately $46,670 from the remaining $70,000 (66.67% inclusion rate).

This brings your total taxable income from the net capital gain down to $171,670 (compared to $225,000) and reduces your total taxable income by over $53,300.

By tax-loss harvesting at the higher inclusion rate, you've managed to save over $53,300 in taxable income while realizing an $80,000 loss.

When planning tax-loss harvesting, understanding year-end deadlines and the T+1 settlement period is critical to ensuring your trades qualify for tax purposes in the current year.

The final trading day for tax-loss harvesting in Canada generally falls a few days before the last business day of December, due to the T+1 settlement period (trade date + 1 business day). For 2024, this means trades must settle by December 31, so the final trading day to complete your tax-loss harvesting for this year is December 30, 2024.

If you wait until December 31 to execute a trade, it won’t settle in time to count for 2024, missing the cut-off for applying the loss to this tax year.

To make sure you’re on track, take these key steps as year-end approaches:

• Plan Ahead: Review your portfolio and identify any securities with unrealized losses that you might consider selling. Early planning gives you more flexibility and helps avoid last-minute trading.
• Confirm Settlement Times: Keep the T+1 settlement rule in mind, especially for securities like stocks and ETFs. This rule means that if you want your losses to be eligible for 2024, you’ll need to execute trades by December 30, 2024.
• Avoid the Rush: The days leading up to year-end are often busy with last-minute trades for tax-loss purposes. Consider scheduling your trades in advance to avoid unexpected delays.

By planning your tax-loss harvesting carefully and staying aware of key dates and settlement timelines, you can help optimize your investment strategy and potentially reduce your tax burden.

When it comes to tax-loss harvesting, it’s important to avoid what’s known as a superficial loss. This rule could invalidate your capital loss if you, your spouse, or even a corporation you control buys back the same or an identical stock within a 61-day window—30 days before or after you sell it.

So how does it work?

1. Timing is key: If you sell a stock at a loss but then buy it back (or someone affiliated with you buys it back) within this 61-day period, the loss becomes “superficial.” This means you can’t use it to reduce capital gains for this year.
   • This means you need to wait a minimum of 30 days after your loss settles before you repurchase the same security for the loss to be allowed.
2. Who is considered affiliated?: This rule doesn’t just apply to you. It also generally covers transactions by your spouse or common-law partner, and any corporations you control.
   • So if an affiliated person repurchases the stock within that time, your loss is denied.
   • Your loss is also denied if you sell the loss security in a personal non-registered account, and then repurchase it within a corporation you own within the 61-day period.
   • Your loss will also be denied if you sell a security in a non-registered account, then repurchase it in a registered account like a TFSA or RRSP within the 61-day period.
3. Avoiding superficial losses: Want to keep exposure to the same sector without violating the rule? Buying a stock in the same industry that is not considered to be identical by the CRA will not count as a superficial loss.
   • Be sure to check the CRA's criteria for identical properties.

    

Important note about options

A call option is deemed an "identical property" to the stock itself, so holding a call option on the 30th day after your sale could still trigger the superficial loss rule.

Superficial loss rules can be nuanced, so it’s important to consult with a professional tax advisor if you’re considering this strategy. Everyone’s portfolio and situation is unique, and tax-loss harvesting may or may not work for you depending on your circumstances.

• Offset Capital Gains: Tax-loss harvesting can help reduce the tax impact on capital gains, which is especially valuable at the end of the year to offset gains from earlier in the tax year.
• Understand Capital Gains Inclusion Rates: Only a portion of your capital gains is taxable, but inclusion rates can differ based on total gains. Knowing these rates and planning accordingly can help you manage tax liabilities effectively.
• Keep Deadlines in Mind: Make trades by December 30, 2024, to ensure they settle in time to be counted for this tax year, avoiding last-minute delays.
• Avoid Superficial Losses: Timing is essential. Wait at least 30 days before repurchasing a sold security to prevent superficial losses from canceling out potential deductions. Be cautious of repurchases by spouses or controlled corporations, as these can also void your capital loss.
• Consider Alternatives to Maintain Market Exposure: If you want exposure to the same sector but need to avoid superficial losses, look for similar but not identical stocks or ETFs to temporarily replace the sold security.
• Consult with a Tax Advisor: Tax-loss harvesting involves many nuances, especially with options and cross-listed securities. Consult a professional to ensure compliance with tax rules and alignment with your financial goals.

Don’t just park your cash

Instead of “parking your cash,” take advantage of reinvestment opportunities in sectors or assets that align with your financial goals and risk tolerance. 

Tax-loss harvesting can also be a perfect moment to rebalance your portfolio, ensuring it reflects your long-term objectives and market conditions. Rebalancing helps you stay aligned with your goals, whether through reinvesting in diversified stocks, ETFs, or other growth-oriented assets.

Ready to start tax-loss harvesting? Log in, and take control of your portfolio today.

Note: The information in this blog is for educational purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied, is made by Questrade, Inc., its affiliates or any other person to its accuracy.