What's Tax Loss Harvesting?

What is tax loss harvesting?

Tax loss harvesting is a strategy you can use if you're investing in the TSE 300. Essentially, when you sell securities (aka stocks, equities, or assets) at a loss in a non-registered account, tax harvesting can offset the capital gains you earn when selling securities at a profit. It’s also known as tax loss selling. 

There’s several reasons why investors utilize this strategy. These include:

• Reducing the amount of capital gains “realized” when selling.
• Preserving the investment portfolio’s value while lowering taxes.
• Using it for portfolio rebalancing (adjusting a portfolio to its original ratio of stocks and bonds).

How does tax loss harvesting work?

When an investment (such as a stock) is sold at a loss, it can be claimed against other investments that were sold at a gain. This way, an investor can lower (or nullify) the amount of tax on capital gains they’ll pay. 

This strategy is called tax loss harvesting and involves selling off investments that have dropped in value and buying comparable (but not identical) investments in the hopes that they will increase in value over time. As for timing, investors typically use this practice toward the end of the year when they review their portfolio’s annual performance and its tax implications.

Rules and guidelines

This section explains which securities and investment accounts you can use for tax loss harvesting, the superficial loss rule, and tips on claiming these losses on your tax return.

Eligible securities for harvesting losses

Here are common securities that can be used for tax loss harvesting:

• Stocks.
• Bonds.
• Exchange-traded funds (ETFs).
• Mutual funds.
• Crypto assets.
• Small business corporation shares.

Which investment accounts benefit from tax loss harvesting?

Non-registered investment accounts benefit from tax loss harvesting in Canada. This is because you’re required to pay capital gains tax when you sell your investments at a profit. However, the capital gains inside registered accounts are not taxed, such as the Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP).

As a result, the Canada Revenue Agency (CRA) doesn’t allow the use of capital losses within registered accounts to offset the capital gains in non-registered accounts. Simply put, you can apply the tax loss harvesting strategy to non-registered accounts—but not to registered accounts like the TFSA and RRSP.

How to report a superficial loss on your tax return

In Canada, investors have the ability to use the superficial loss rule. Now, this may sound like a fancy term, but it's pretty simple. Here’s how it works:

You can’t sell an asset at a loss and buy the same asset back within 30 days. The CRA knows about this loophole and considers it a superficial loss. Unfortunately, you won’t be able to report the superficial loss on your tax return. Instead, you need to wait 30 days to buy back the same asset in order to report it as a real capital loss.

Note: Our U.S. friends south of the border call this the "wash sale rule."

Tips on filing your taxes

Here are a few important tips to keep in mind when filing your taxes with the CRA:

1. Capital losses can only be applied in years where there are capital gains. 
2. Capital losses can be used to reduce capital gains in the current year, the 3 preceding years, or in any future year. For example, if you incurred capital losses in the 2024 tax year, you could apply it to the 3 preceding years (2021, 2022, and 2023), the current tax year 2024, or the years ahead.

Can business loss be offset against capital gains?

If you incurred a business loss, you may be eligible to deduct half of the loss from your income. The amount you can deduct is known as the allowable business investment loss (ABIL). Losses can include small business corporation shares and any debt that’s owed to you from another small business.

Advantages of tax loss harvesting

When you handle capital gains and losses in your taxable accounts, there are several benefits that come with it, such as:

• Capitalizing on market fluctuations, since investments can go up and down in value.
• Rebalancing your portfolio to improve your asset allocation.
• Minimizing the negative impact of losses within your portfolio.
• Enhancing tax efficiency in non-registered investment accounts.
• Focusing on long-term wealth accumulation to achieve your financial goals.

When filing your taxes this year, if you need assistance applying the tax loss harvesting strategy, consider speaking with a tax professional.

Example of tax loss harvesting

Here’s an example of how you can apply the tax loss harvesting method:

Let’s say you bought Stock A for $25,000. The value decreased to $10,000. 

You decide to sell it at a capital loss of $15,000 ($10,000 - $25,000 = -$15,000) in July 2024.

Then, you bought Stock B for $10,000. The value increased to $30,000. 

You decide to sell it at a capital gain of $20,000 ($30,000 - $10,000 = $20,000) in August 2024.

You can apply the loss of $15,000 of Stock A against the profit of $20,000 of Stock B ($20,000 - $15,000 = $5,000), providing savings on the tax owed on Stock B. This is essentially how you are “harvesting the loss.”

So, instead of paying taxes on $20,000 of capital gains, you’ll now pay taxes on $5,000. 

Finally, you’ll need to pay capital gains tax on 50% of your $5,000 profit, which totals $2,500 ($5,000 x 0.50 = $2,500).  

However, if you didn’t apply the tax loss harvesting strategy, you would need to pay capital gains on 50% of your profit of $20,000, which totals $10,000 ($20,000 x 0.50 = $10,000). 

The amount of tax you’ll pay will depend on which tax bracket you fall into when you file your taxes.

This example demonstrates how tax loss harvesting can be financially beneficial for investors.

Optimizing your investment returns

Investors should consider exploring tax loss harvesting strategies to see how they could lessen their tax burden. Although the strategy may not help to recover losses incurred, if applied correctly, it could potentially maximize investment returns through tax optimization.

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