Capital losses top year-end tax planning priorities

Maybe more than in any other year, this tax season, tax loss planning will be a vital area where advisors can add value. In order to take advantage of capital losses this year, securities must be sold by December 24, which means advisors have to start strategizing now if their clients should be selling stock to get a tax benefit.

Markets have fallen substantially this year, but clients likely paid some capital gains in the previous three years. Now is the time to get some of that money back for them.

“Tax loss planning is a little more important than usual because people have more losses than they had before,” says Gena Katz, executive director of the tax group for Ernst ∓ Young. “Capital losses are certainly a way to ease the financial blow people have taken this year — you can at least take advantage of the markets in terms of income tax.”

Katz notes that the basic premise of tax loss planning is that clients can sell a security for a loss this year, and then use that loss to offset any capital gains they may have incurred within the past three years. You can only write off the loss if you have actually disposed of the securities. Losses are only claimable against capital gains.

“You can carry capital losses forward to other tax years — they never expire. You really want to get the benefit currently or for the three preceding tax years,” Katz says.

There are some catches, though, to taking advantages of capital losses. The most important is that any security sold cannot be repurchased for 30 days. This prevents value-oriented investors from selling, banking the capital losses and then immediately repurchasing the stock to take advantage of depressed prices. This is considered a superficial loss and cannot be applied as an offset to capital gains.

Clients who wants to sell an investment have to take a long hard look with their advisor as to whether there would be value in holding the stock over the next month rather than selling it. That’s not an easy decision in these volatile markets.

Katz also warns investors against accruing additional superficial losses by selling securities within an RRSP or selling an investment outside of an RRSP and then repurchasing it within the RRSP.

“Whatever you sell within your RRSP, neither gains nor losses are realized. People have to watch out for that,” she says. “Superficial loss will apply if you sell something for a loss and your RRSP is acquiring the security within 30 days.”

It is possible for clients to transfer capital losses to their spouse to use.

“The situation could be such that you’re holding on to securities in loss position, but you can’t benefit from a capital loss situation. If you have a spouse or partner that had capital gains earlier in the year you can sell the security to your spouse. It must be a real sale, in other words, your spouse provides proceeds for whatever the value of the security is,” Katz says. “The seller doesn’t get direct benefit of the loss, but their spouse has securities with a higher cost base because of the superficial loss rules. If the spouse waits 30 days to sell in the market, the spouse claims the loss and gets [the tax benefits] of selling the shares.”

Myron Knodel, director of tax and estate planning from Investors Group, says, apart from tax-loss planning, there are some other areas where advisors should be doing some tax planning before the end of the year, such as Registered Education Savings Plan contribution deadlines.

“If you make a contribution the government gives you a 20% grant in addition to the contribution you made. If you have a child turning 15 in 2008 and you want to obtain the credits from this year and the next two years, you must actually make a contribution by December 31,” Knodel says.

Knodel says the same contribution rules apply for clients with RRSP contribution room and who are turning 71 in 2008.

“If you’re turning 71 in 2008 and you have RRSP contribution room, you have to actually make your final RRSP contribution by December 31. You don’t have until the end of February to make that contribution,” he says. “If your clients turned 71 this year make sure they convert their RRSP to a RRIF by the end of December.”

With the holiday season fast approaching, advisors or clients may be looking to give employees a gift. You are allowed to give a non-cash or cash-transferable gift with a value of up to $500 without it being taxable to the employee.

“If you’re giving a gift commemorating the contribution of an employee, you can make a non-cash gift of up to $500, which must be done by the end of December,” he says. “The gift must be something that can’t be converted into cash.”

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(10/23/08)