Lost Money on an Investment? Canada’s Tax-Loss Harvesting Strategy Could Reduce Your Capital Gains Tax

Key Takeaways

• Selling a losing investment in a non-registered account can realize a capital loss that generally offsets capital gains.
• Net capital losses may generally be carried back up to three years or carried forward indefinitely for use against taxable capital gains.
• Buying identical property within the 61-day superficial-loss window can deny the immediate loss claim, including when an affiliated person buys it.

How Tax-Loss Harvesting Works

Imagine you own two investments in a non-registered account.

You sell Investment A and realize a $20,000 capital gain.

Meanwhile, Investment B has performed badly. You invested $30,000, and it is now worth $20,000.

You are sitting on an unrealized loss of $10,000.

If you continue holding Investment B, the decline in its market value generally doesn't create a capital loss for tax purposes.

But suppose you sell it.

You have now realized a $10,000 capital loss.

That loss can generally be applied against capital gains, reducing your net capital gain before the applicable capital-gains inclusion rate is applied.

In this simplified example:

$20,000 capital gain − $10,000 capital loss = $10,000 net capital gain

You lost money on Investment B either way. Tax-loss harvesting simply attempts to make that realized loss useful from a tax perspective.

What If You Don't Have Capital Gains This Year?

This is where Canada's rules become particularly useful.

A net capital loss generally doesn't disappear simply because you cannot use it this year.

The Canada Revenue Agency allows net capital losses to generally be carried back up to three years or carried forward indefinitely.

Imagine you realize a $15,000 capital loss this year but have no capital gains.

If you reported taxable capital gains in one of the previous three years, you may be able to carry the net capital loss back. Otherwise, it may remain available for use against taxable capital gains in a future year.

There is an important distinction: ordinary capital losses generally offset taxable capital gains. They generally cannot simply be deducted against employment income such as your salary.

The 30-Day Trap

This is where tax-loss harvesting gets more interesting.

Imagine you bought shares of XYZ Company for $20,000.

They fall to $14,000, so you sell them and appear to realize a $6,000 capital loss.

Two days later, the shares fall again.

You think:

"They're even cheaper now. I'll just buy them back."

From an investing perspective, that might seem perfectly reasonable.

From a tax perspective, you may have just created a problem.

Canada's superficial-loss rules are designed to prevent taxpayers from realizing certain losses for tax purposes while quickly maintaining or restoring ownership of the same or identical property.

Broadly, the rule can apply when you or an affiliated person acquires the same or identical property during the period beginning 30 calendar days before the sale and ending 30 calendar days after the sale, and the purchaser still owns or has a right to acquire the substituted property 30 days after the sale.

That creates a 61-day window surrounding the transaction.

If the superficial-loss rule applies, you generally cannot claim the loss immediately.

Your Spouse's Account Can Matter Too

What if you sell the investment and your spouse buys it instead?

That may look like a workaround. For tax purposes, it may not be.

Canada's superficial-loss rules can involve acquisitions by affiliated persons, which include a spouse or common-law partner.

That makes tax-loss harvesting more complicated for households where spouses hold similar investments across different accounts.

Before executing a significant tax-loss harvesting transaction, it can therefore be worth checking recent purchases across relevant household accounts rather than looking only at your own portfolio.

What Happens to a Superficial Loss?

A superficial loss isn't necessarily economically lost forever.

In many situations, the denied loss is added to the adjusted cost base of the substituted property. That can potentially reduce a future capital gain or increase a future capital loss when that property is eventually sold.

But the immediate tax benefit you were attempting to create may disappear.

There are also situations where the tax treatment can be different, including transactions involving registered accounts. Investors should therefore not assume that every denied superficial loss will eventually become recoverable through a higher adjusted cost base.

The important lesson is simple: selling an ETF on Monday and buying the identical ETF again on Tuesday isn't the tax shortcut it might initially appear to be.

Can You Buy Something Else Instead?

Potentially.

An investor may sometimes sell one investment and purchase another that provides broadly similar market exposure without acquiring property considered identical for tax purposes.

For example, someone selling a broad-market ETF might consider another fund with different underlying characteristics while maintaining similar exposure.

But there is an important warning.

A different ticker symbol, fund provider or index does not automatically mean two investments aren't considered identical property for tax purposes.

Whether investments are considered identical can depend on their legal and economic characteristics.

And taxes shouldn't control the entire investment decision.

Transaction costs, bid-ask spreads, portfolio allocation, risk differences and the possibility that the original investment rises while you are out of it can all affect whether harvesting the loss actually makes sense.

Tax-Loss Harvesting Doesn't Work the Same Way Inside a TFSA or RRSP

Tax-loss harvesting is primarily relevant to investments held in taxable, non-registered accounts.

Suppose an investment inside your TFSA falls from $20,000 to $10,000.

Selling it doesn't create a $10,000 capital loss that you can use against capital gains in your non-registered investment account.

The same general principle applies to investments held inside an RRSP: investment losses within the plan aren't treated as deductible capital losses in the way losses on investments in a taxable account can be.

That means the same $10,000 decline can have very different tax consequences depending on which account holds the investment.

It is also important to be particularly careful when moving between non-registered and registered accounts because superficial-loss rules can create results that are more complicated than simply waiting to claim the loss later.

Don't Let Taxes Control Your Portfolio

Tax-loss harvesting can be useful, but creating a tax benefit shouldn't become the objective of investing.

You are still realizing an actual investment loss.

Selling a terrible investment purely because it has fallen isn't suddenly a brilliant strategy because there is a tax benefit attached to it.

The strategy becomes more interesting when you already have an investment you are comfortable selling, the transaction fits your broader portfolio plan and the realized loss can be put to productive tax use.

Used carefully, a losing investment can potentially reduce the tax impact of a winning one.

Used carelessly, the superficial-loss rule can eliminate the immediate deduction you were expecting.

Sometimes the smartest part of tax-loss harvesting isn't knowing what to sell.

It's knowing what not to buy back too quickly.

This article is for general informational purposes only and is not individualized tax, legal or investment advice. Tax treatment depends on individual circumstances and the specific investments and accounts involved.