Making the most of year-end losses

Canadian Shareowner, Nov/Dec 2000 by Leigh Vyn

It's hard to believe that the year 2000 is quickly coming to a close. After all the hype and publicity about the new millennium, it seems like this year has come and gone in a flash. But even when we change our calendars over, the year 2000 will still leave many people one last thing to take care of--the tax bill. For some investors the year 2000 was a great year, but for others it was not so great. Whether this was a good or bad year for you, you may be able to use your existing investments to help reduce your tax bill before the end of the year. Let's look at how.

Triggering Losses

With the boom in technology stocks we saw early this year, it is quite likely that many Canadians will report capital gains on their 2000 tax return, accompanied by a pretty hefty tax bill. But there may be a way to reduce this gain, if some of the other investments you still hold have dropped in value since you purchased them. You see, by selling these losing investments before the end of this year, you'll trigger capital losses. These losses can then be used to reduce your capital gains, and your total tax bill.

The problem for some people is the notion of parting with the losing investment. Although the investment is down right now, they have every confidence that it'll spring right back in no time. Their solution is to sell the investment and trigger the loss, use the loss against the taxable gain, and then repurchase the stock. That way they'll be sure they still own the stock when it eventually recovers. Although this sounds great, there is a problem with this strategy.

Superficial Loss Rules

The problem is the superficial loss rules. If the investments are repurchased within a certain time, the capital loss triggered on their original sale is considered to be "superficial" a nice word the taxman uses for useless. This means that the losses cannot be used to offset any capital gains from tax. The superficial loss rules are found in Section 54 of the Income Tax Act which states that a loss will be labled superficial if you, or someone affiliated to you, repurchases the investment within thirty days either before or after, your sale of the investment. Affiliated persons include you, your spouse, or your corporation but does not include your parents, children, nieces or nephews.

For example, suppose you sold shares of ABC Company on November 5, 2000 and someone affiliated with you bought or repurchased the same investment at any time between October 6 and December 5 inclusive (a sixty-one day window), the rules would deny you the use of the loss. The amount of the denied loss is not lost forever. It is added to the cost base of the shares, to reduce the gain when they are ultimately sold.

Re--acquiring Stock Inside RRSP

For those of you who can't wait thirty days after you sell your investment to reacquire it, there is a solution. You can repurchase the investments inside your RRSP without having to worry about the superficial loss rules. Remember that the superficial loss rules will only apply if someone affiliated with you purchases the investment. When you check out the definition of "affiliated" in the Income Tax Act, there is no mention of an individual being affiliated with a trust (an RRSP is a trust). Therefore, you can sell your investment on the open market for a loss, use that loss against any capital gains, and then use the proceeds to contribute to your RRSP. Once inside your RRSP, you can use that cash to repurchase the investment. Keep in mind that in order to do this you must have enough RRSP contribution room available.

I'm sure that many of you are now thinking, "That seems awfully complicated. Can't I just contribute my losing investments to my RRSP, and claim the loss?". The answer is no. When you make a contribution in kind to your RRSP, you are deemed to have disposed of the asset at its current fair market value. If the asset has declined in value there will be a capital loss. The problem is that this loss is denied. Of course, if you transfer an asset with an accrued gain, Canada Customs and Revenue Agency (CCRA) will be right there to tax the gain. Because the loss is denied, you're better off selling the asset, triggering the loss, and contributing the cash proceeds.

Prior Year Gains

With all this talk about selling investments at a loss, I want to make it clear that generally it doesn't make sense from a tax perspective to sell assets at a loss unless you already have capital gains to claim them against. Even if you have no capital gains to report in 2000, you can still make the most of any investments that may have declined in value this year. Capital losses can be carried back three years to offset any capital gains in that period, as well as carried forward indefinitely. This means if you've reported a capital gain in 1997, 1998, or 1999, you can carry back a loss to these years and receive a refund for the taxes you paid on the gain. Simply complete form TIA requesting that the capital loss be carried back, and include this form with your 2000 income tax return.