Tax-loss selling might ease your clients' pain

It’s not easy to find a silver lining in this economic downturn, but tax-savvy advisors don’t need to look too hard to uncover a saving grace: tax-loss selling.

This year — maybe more than any other — tax-loss planning will be a vital area in which advisors can add value, though stocks have to be sold by December 24 in order to make their depreciated securities work for your client.

“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.”

The advantage to a capital loss is that your client can use it to offset any capital gains he or she may have incurred in the past three years by selling a stock at a higher price than it was originally bought for.

“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.

If a client has no capital gains, says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, capital losses can be carried forward indefinitely to offset future capital gains.

As well, if a client has no capital gains, losses can be transferred to his or her spouse.

“The situation could be such that you’re holding on to securities in a loss position, but you can’t benefit from a capital loss situation,” says Katz. “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.

“The seller doesn’t get direct benefit of the loss,” she adds, “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.”

While tax-loss selling will benefit plenty of panicky investors who cashed out when the markets were down, it will especially help clients holding BCE stocks, as they’re about to get hit with massive capital gains when the company goes private in December.

“For many people, this will trigger a significant gain,” Golombek explains. “Therefore, realizing capital losses would be another way to offset the tax hit.”

“For people who have non-RRSPs and Bell shares, their advisors should be taking advantage of some form of tax loss,” adds Robert Abboud, president of Wealth Strategies, an Orleans, Ont.-based financial planning firm.

There are some catches, though, to taking advantage 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.

With the market as volatile as it is, advisors need to take a hard look at whether or not selling a stock for the capital loss is worth it. If the client wants to buy the stock back after 30 days, the price could have shot up.

Abboud, however, thinks he has figured out a way to circumvent the 30-day rule. He says most companies offer corporate class structure versions of their funds, and while switching from a regular offering to this class creates a capital loss, it doesn’t trigger the waiting period.

“They can sell the retail version of a fund today at four and buy the corporate class today at four,” says Abboud. “It’s simply a switch. A strategy for creating a capital loss while staying in the market.”

While this might work, Katz cautions 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. “A superficial loss will apply if you sell something for a loss and your RRSP is acquiring the security within 30 days.”

While using a capital loss to lessen the tax hit this year is one way to ease a client’s financial-meltdown-related pain, Abboud and Golombek caution investors who think they should get out of the market just for tax purposes.

“You don’t want to make a decision that’s tax-driven,” says Golombek. “If you believe you’ve got a good investment for the long term, it rarely makes sense to simply do something for tax reasons and ignore the investment approach.”

“This doesn’t mean get out of the market,” adds Abboud, “but advisors should get creative.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com and Mark Noble mark.noble@advisor.rogers.com

(11/04/08)