Using Capital Losses to offset Capital Gains
Some investors planning for retirement using exclusively registered accounts such as RRSPs and TFSAs, and/or contributing to a generous workplace pension plan (if they are lucky enough to have one) may not need to worry about managing capital gains or losses. In addition to registered accounts some investors may choose to use taxable accounts to save for retirement. Let’s look at some facts before my case study.
Some Capital Gains Facts
- A capital gain occurs when you make money from selling an investment for more than you paid for it.
- If you have capital gains for investments inside a Registered Retirement Savings Plan (RRSP), capital gains are not taxed until the money is withdrawn from the account, where at that point, the amount of the withdrawal is taxable income for that year.
- If you have capital gains for investments inside a Tax-Free Savings Account (TFSA), capital gains earned are not taxed. Generally, interest, dividends, or the aforementioned capital gains earned on investments inside a TFSA are not subject to tax-either while held inside the account or when money is withdrawn from the account; it’s a true tax shelter once monies are contributed to it. There are some situations however where tax is payable on TFSAs and you can read about that here.
- Unlike regular, employment income or interest earned from savings accounts or bonds, capital gains are not taxed at your full marginal rate. If fact, in taxable (non-registered accounts), capital gains are taxed quite favourably since you only pay gains when they are realized. When you decide to realize the gains you pay tax on 50% of the gains. A quick example: a $1,000 gain x 50% = $500 taxable at your marginal tax rate. You can find the marginal tax rates for individuals (current to the time of this post of course) here.
Some Capital Losses Facts
- A capital loss is the loss you “realize” (that word again) when you sell an investment for less than you paid for it.
- A capital loss can be used to reduce capital gains incurred during the same tax year (actually, I believe capital losses must first be used to offset gains you’ve incurred in the current tax year).
- A capital loss can be used to reduce gains incurred to any of the preceding three (3) tax years, or can they can be banked for use against future capital gains.
- A capital loss typically cannot be used to reduce other income.
- Capital losses inside RRSPs or TFSAs are not deductible.
- Capital losses must be recorded (on the tax return) in the year they are realized.
My Case Study
A while back, I sold a dud in my portfolio in my taxable account.
Because this stock was in a taxable account I could realize the loss now since I expect to pay some capital gains on some investments in future tax years.
Meaning, if you don’t have capital gains in either the current tax year or any of the previous three, you may opt to carry your losses forward. Each year, the accumulated value of your capital losses becomes your net capital losses, which you may carry forward indefinitely.
I think this was a good call but I suppose I’m biased, otherwise I wouldn’t have done it. I decided to cut the loser, pick myself off the ground and move on. What did I do with the funds? Nothing for now. Did I make the right move? What do you think?
The punchline: as part of your year-end financial planning consider selling some duds in your portfolio to realize capital losses to offset capital gains incurred with any stock studs.
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
Selling the losers is a great way to reduce your capital gains. I may have to do something similar before the end of the year too. 🙂
Ha, well, ideally I would have no capital losses but it’s difficult to do; this was really my only big dud though which is good.
You should not be adverse to playing with your TFSA as long as you follow the guidelines.
As an example, when starting off there is obvioulsy a small amount to invest and therefor a small return on investment if you are a dividend investor like me.
So for the first few years I would withdraw the dividends paid out and apply them to my HELOC @3% intterest. So at least it was “paying” me 3% to pay down the HELOC. Come January I would max the contribution plus the withdrawn monies and invest them in one shot. This lowered brokerage charges obvioulsy as investing very small amounts every few months can be prohibitive on a cost basis.
This is the first year I have retained earnings in the TFSA and re-invested them. Naturally the dividends will increase quaterly making it more and more profitable and cost effective.
Having said all that I have just withdrawn my Nov dividends from my TFSA and will do so with the Dec divs as well. Why? Becasue I can apply them against the HELOC right now for 3% and the wait period to re-invest the money is just a few weeks away. In the mean time it is paying me 3% rather than nothing. As mentioned, investing a hundred dollars each month is prohibitive on a COP basis. I do hold during the year as every quarter is a larger dividend month so it is worth it to hold in the account. It is just at the end of the year now that I can better utilize the money to earn me some money rather than sitting on it till 2015.
Also some banks are offering “special” investment accounts such as for an RRSP or TFSA at a higher interest rate (2%) than a chequing account (0%). So if you have some money sitting there waiting for January that you know you are going to use for either account then you might as well make a little bit of money on it and then come January you collapse the account and put your money to work where you want it. Also, if you can’t spot a nice stock right away you can hold the money in these accounts until you are ready to buy. I believe you have till MArch to transfer the money to a TFSA or RRSP.
Check with you bank if you have a few thou sitting there not paying you anything.
Well, I avoid trading in my registered accounts. Pretty much a buy and holder.
With loan rates as low as they are now, it might make sense for some investors to use the dividend paid to apply to a HELOC around/at 3%.
I don’t mind saving for 2015, I don’t have very much money saved up so I need to really start saving more for the TFSA next year. I hope to max it out again but it will be tough to do given all our other financial priorities (contributing to RRSP and killing debt).
You’re right about the timelines, you have until the first 60 days of 2015 to contribute to the RRSP to use for the 2014 tax year.
Hi Mark;
I agree with you that you do not want o play too much in the registered accounts. But, as an example, the TFSA in the first year paid only $142 in dividends. So considering that this was paid out quarterly it would not have been cost effective to re-invest them unless they were dripped.
So I just withdrew them and paid down the HELOC to the magnainmous sum of $142 but it “saved” me 3% on that money. Come the following January I contributed the $5K (at that time) plus the $142 and invested that in one shot.
For 2014 I have retained the dividends within the TFSA and re-invest them simply becasue the dividends have grown to over $2.6K per year so it is well worht while to re-invest them quarterly and thereby raise the dividends every month or quarter, depending on the stock purchased.
Obviously in an RRSP you can not withdraw the money with incurring major taxation. But don’t be afraid to wisely use your TFSA especially when starting out. Just leaving money sitting there is not necessarily a wise use of it.
Your advice is well taken, we try and max out our TFSAs every year and certainly don’t leave too much money around. We don’t have very much money invested to begin with, so every few bucks in the market helps!
As for DRIPping and reinvesting dividends, you’re writing to the converted, I DRIP almost everything I own and have no intentions to stop!
https://www.myownadvisor.ca/october-2014-dividend-income-update/
Thanks for reading and commenting, always great to hear from passionate investors like yourself.
Mark
Is it acceptable to transfer a stock which includes some capital gains, from a taxable account to your TFSA without incurring payment of the capital gains?
You can certainly move the stock from non-reg. to TFSA Maurice, but it happens this way:
https://www.myownadvisor.ca/tax-free-investing-tfsas-101/
“If you want to contribute investments “in-kind” to your TFSA, you can, but you are considered to have sold investments for their fair market value before doing so and may need to pay a capital gain.”
In fact, I have done this and will likely do it again, move stocks from non-reg. to TFSA because while I’m working, tax-free is much better than tax-efficient (i.e., dividend tax credit).
It is part of the investing equation most are not comfortable with… selling a loser… it is unfortunate that you might have to come to grips with having picked a loser, but it is best to just get over it, and move on… Again, a very important part of the investing skill set that most are not good at. Good on ya for learning that sometimes you just need to cut the cord. Now there is another side to this too and food for thought for you, but when is it time to sell a winner and realize the capital gain? 😉 – Cheers.
Yes, selling a dud and selling a winner, not easy to do, which is why I think indexing can work for most people: you don’t really need to care what the market does; you ride the coattails of the market returns.
I know I made the right call, I’m just kicking myself for holding that stock in the first place Phil.
Regarding my winners, I will be realizing some capital gains eventually but not when I’m working; I will try and avoid selling stocks (with a major gain) until my tax rate is lower, i.e., debt on house is done, working part-time, etc. I could use the loss for any TFSA contributions in 2015, not sure yet.
I sold TA in September. I was converting some of my TSX listed ETFs to lower cost US listed ETFs and figured I’d sell TA to offset some of the capital gains.
TA no longer really fit into my portfolio strategy, so I had been looking to get rid of it, but I had a hard time telling how much the poor performance was influencing my decision. The fact that you came up with the same conclusion as me at around the same time makes me wonder how many people have been selling for the same reasons.
I would guess a number of investors “got tired” of hanging on and cut the cord with TA. I know I’m done with this company for good and will be moving the proceeds leftover to indexed products.
Morning Mark;
A good idea to “bank” loses for possible future gains.
I run a HELOC for investment purposes. I have split the account in to two separate investment accounts for the following reasons.
1) All dividends from the investment account tied to the HELOC are automatically transferred to pay down the interest and principle. I can not touch this money or any profit from sales (cap gains) of stocks. The transfer of any “cash” in the investment account is automatic. Good security for the bank.
2) I opened up a second investment account not tied to the HELOC and transferred some shares to it. Any sales, profits or losses, are held in the account and DO NOT go back to service the HELOC.
3) ALL cap gains or losses are still attributable to my income as they are non-registered accounts.so as far as the CRS is concerned there is nothing shady.
4) I hold mainly the “losers” in the second account so that if I decide to sell for what ever reason I can bank the “loss” and utilize the money for what I want – pay down th eprinciple or , like this year, buy a car.
5) Dividends from the HELOC account MUST be able to pay the interest on th eHELOC plus some of the principle. My own criteria
6) Once I start to utilize the equity in these accounts to fund my retirement, sell stocks, I will have some loses built to cover the cap gains at that time at a lower tax rate.
7) As long as the accounts cover the HELOC interest payments I will not collapse them. Once I approach that stage I will collapse the accounts, sell stocks, and eliminate the HELOC. From then on I will be on QPP, OAS, RRSP and TFSA revenues
This way I can reduce any cap gains while I am working and therefor at a higher tax rate while building the tax loss basis.
Richard
Love these great comments Richard, a detailed strategy for sure.
No doubt I can see why you have dividend-investing tied to the HELOC, you need to find a way to kill the debt (eventually) at a rate that exceeds the loan min. payment.
I’m trying to avoid “losers” which is why I will be indexing more in 2015. I don’t want to go down the same road again, selling a dud.
Our revenue streams differ a bit in the end, I see withdrawals from RRSP but not TFSA or the non-reg. accounts. I hope to keep the capital for TFSA and non-reg. intact until old age.
TFSA would probably be the last thing I would touch as well but as I told my doctor i expected him to keep me in shape untill 200 I just may have to dip in to it. LOL
Good one 🙂
Mark,
You did the right thing. TA is going nowhere. Now you have a tax deduction banked, you have cash to invest and have gotten rid of a pain in the portfolio. Well done!
Regards
John
Thanks John, and the deduction is banked. Now more indexing 🙂
Mark,
I sure hope you are not talking about using a Canadian Index ETFs. They are skewed too much towards energy and materials. In good times they are great, but in bad times not so good. I believe you are better off selecting good Canadian companies with good dividends rather than a Canadian Index. You can do a better job of diversification yourself. Indexes are great for foreign investments. Don’t give up on individual stocks because of one bad call.
Regards
John
Hey John,
No, leaning towards taking the funds and investing in the U.S. market. I won’t be pulling out those funds for about 10-15 years, maybe more.
Yes, our CDN economy is skewed to financials and energy companies. As CDN banks, lifecos and energy companies go, so does our economy.
I don’t intend on selling my other dividend payers 🙂