Reviewing your investment portfolio to identify tax planning opportunities before the end of the year is always a wise decision.
In last week’s column, I discussed several tax planning ideas that should be considered before the end of the year.
One of the concepts that I mentioned but didn’t explain (due to lack of space) is called “selling tax losses”. I decided to follow up this week and explain a little more.
How does the “tax loss sale” work?
Tax losses sold today can be used to free up additional cash flow when you file this year’s taxes next spring. If you recognize capital losses on your unregistered investments that year and those losses exceed the capital gains recorded that year, the losses can be taken back to offset the net capital gains recorded in any of the past three tax years.
This may result in a tax refund for previous years in which net capital gains were reported. Capital losses that cannot be offset against capital gains in the current year or in the last three tax years can be carried forward into the future for an indefinite period of time.
If the capital losses cannot be used immediately, either through a loss carry-back strategy or as a claim to capital gains expected this year or in the near future, there is usually no tax reason for realizing such losses today.
However, there are complex tax rules out there that can deny the loss of capital you might want to realize.
Pay attention to the rules for “superficial loss”
Superficial loss rules are designed to prevent you from realizing and claiming a loss of capital for tax purposes when your real intention is not to sell the property. These rules deny some (or all) of the loss for tax purposes if certain conditions are met.
The Superficial Loss Rules apply when:
• During the period beginning 30 days before a disposition and ending 30 days after a disposition, you or someone connected to you will acquire real estate (referred to as “replaced property”) that is the same or “identical property” “Acts. , and
• At the end of this period, you or someone connected with you will own or have had the right to purchase the replaced property
Double taxation is avoided by adding the amount of superficial loss to the adjusted cost base of the property being replaced, leaving you with the same tax position on the property being replaced as it was before the transactions. There is no tax advantage, but also no tax disadvantage.
What are “identical properties”?
The focus of the superficial loss rules is the definition of an identical property. Identical properties are properties that are the same in all essential respects, so that one interested party would not prefer another.
Who is a “Connected Person”?
Damage also falls under the definition of superficial damage if the property being replaced is not acquired by you but by a “connected person”. The definition of “connected person” is quite broad and encompasses the following relationships:
• You and your spouse or domestic partner
• You and a corporation or partnership controlled by you, your spouse or domestic partner
• A trust and its majority owner or spouse
Here is an example of how shallow loss rules work:
On January 31, 2021, an investor bought 100 shares of ABC Inc. for $ 100 per share.
The shares lost value, and on May 1, 2021, the investor sold the shares for $ 70 per share.
The investor repurchased the same shares in ABC Inc. two days after the sale for $ 70 per share.
The superficial loss rules will add the loss of $ 30 per share to the new shares of ABC Inc. and the capital loss is not enforceable. Therefore, the ABC Inc. shares acquired on May 3, 2021 will have an ACB of $ 100 per share, not $ 70 per share.
If the investor subsequently sells the shares in ABC Inc. in 2022, the realized capital gain will be the same as it would have been if the investor had never sold the original shares again in May 2021.
Selling tax losses is complicated, and understanding the potential tax implications is important when considering this approach.
Check with your advisor to understand how such losses can work for you and to ensure that losses you incur can be recovered as intended.