Nobody sets out to lose money when they invest, but as the saying goes, you can’t win ’em all. Even top professionals miss the mark at times, which leads to another saying about turning lemons into lemonade. That’s the gist of “tax-loss selling,” a strategy of using losses to reduce overall investment taxes in non-registered accounts (i.e., excluding accounts like RRSPs and RRIFs).

No investor wants to pay more income tax than required. The more you can reduce your tax owing, the more money you’ll have available to invest and save for the future. Here’s how tax-loss selling works.

During the year, you may have sold certain securities – stocks, bonds, funds, non-primary-residence real estate, etc. – at a price that’s higher than what you had paid. The profit on such a sale is considered a taxable capital gain that’s included on your income tax return. In recent years the inclusion rate for capital gains has been 50%, but Canada’s 2024 Federal Budget proposed that individuals must include, for taxation purposes, 66.67% of their annual capital gains above $250,000. That means you could give up more of your gains to income tax, if realized on or after June 25, 2024.

Example of tax-loss selling

One way to help reduce the impact of capital gains tax is to apply capital losses against them. Every dollar of capital losses will lower your total capital gains by one dollar, leading to less tax payable. The following hypothetical example illustrates the concept of tax-loss selling.

Let’s say you bought 500 units of ABC mutual fund in 2021 at $20 per unit. Your total purchase cost (we’ll ignore sales charges, fund fees, etc. for this example) was $10,000. It’s now 2024 and your investment is doing well, as the unit price has risen to $27.25. You decide it’s an appropriate time to take your profits from this investment, so you sell the 500 units for $13,625. Since your original cost to invest was $10,000, you’re left with a capital gain of $3,625.

Anticipating a hefty tax bill, you look for ways to reduce the capital gain. You notice an investment in XYZ stock has been performing poorly, and research suggests the stock isn’t expected to rebound soon. You had purchased 1,000 shares of XYZ stock in 2020 at $12 per share, and it’s currently trading at $9 per share. Excluding commission fees, your capital loss is $3,000 (i.e., $12,000 original cost, minus $9,000 sale proceeds).

Assuming you only sold ABC fund and XYZ stock in this calendar year, your $3,625 capital gain is mostly offset by your $3,000 capital loss, leaving only $625 in gains (50% of which is taxable). That’s the tax-mitigating effect of tax-loss selling.

Points to remember

Keep in mind you must sell your losing investment by the year’s last trading settlement day to apply capital losses against any gains earned during the year. If you don’t need to use all of the accrued capital losses in a given tax year, you may carry them back – up to three years – to help offset past gains, or carry them forward indefinitely to lower future capital gains tax.

As well, be careful not to repurchase the same securities you had sold within 30 days after this sale, and ensure you hadn’t purchased them 30 days or less before the sale date. If either circumstance applies, your loss may be considered “superficial” and not be eligible as a capital loss.

Ahead of each income tax season (e.g., in November or early December), review your investment portfolio to determine the year’s potential capital gains and losses. An Alterna Advisor can help you calculate the taxes due from your investments, and whether or not you could benefit from tax-loss selling.