Tax-loss selling comes with a raft of potential benefits, but it nevertheless has some strings attached — deadlines, for example.
As 2019 comes to a close, investors may want to consider looking at tax-loss selling and how to use the strategy to their benefit.
Buying stocks low and selling them high is ideal, but sometimes investments go sour. In such cases, all hope is not lost — investors have the option to sell investments that provided losses instead of capital gains at the end of the year.
The money made from selling off the loss can then be used to offset capital gains made throughout the year. This is the principle behind tax loss selling.
Tax-loss selling: How does it work?
Tax-loss selling is the sale of stocks at a loss in order to reduce the capital gain earned on an investment. Since capital loss is tax-deductible, the loss can be used to offset any capital gains to reduce an investor’s tax liability on their tax return.
As an example of tax-loss selling for tax savings, imagine if an investor bought 1,000 shares of a company for US$53 each — they could sell the shares and take a loss of US$3,000 in the event that they declined in value to US$50 each. The US$3,000 loss from the sale could then be used to offset gains elsewhere in the investor’s portfolio during that tax year.
Tax-loss selling, or loss harvesting as some refer to it, generally involves investments with huge losses, and because of this, these sales generally focus on a relatively small number of securities within the public markets. However, if a large number of sellers were to execute a sell order in tandem, the price of the securities falls.
It’s worth noting that once selling season has come to a close, shares that become largely oversold have an opportunity to bounce back. In addition, the fact that tax-loss selling often occurs in November and December — during a time when investors are actively trying to realize capital losses for the upcoming income tax season — the most attractive securities for tax selling are investments that are most likely to generate strong capital gains early in the next year.
Due to this fact, a potentially beneficial strategy for investors would be to buy during the selling season and sell after the tax-loss has been established. This strategy could be used on either long-term capital gains tax or short-term capital gains tax.
Due to the appeal of the tax-deductibility of losses, some investors may consider selling an asset at a loss, deducting that loss for a tax gain, and then turning around and purchasing the exact stock again once again in an effort to evade taxes — this is known as a wash sale. Unfortunately, a wash sale is prohibited by the Internal Revenue Service (IRS). If the IRS deems a transaction to be a wash, the investor would not be allowed any tax benefits.
In order to avoid tax-loss selling to be deemed a wash, investors need to wait 30 days in order to repurchase the shares that were originally sold for a loss. Additionally, shares sold for a loss must have been in the investor’s possession for more than 30 days.
Tax-loss selling: Save the date
Tax-loss selling comes with many potential benefits, but it nevertheless has some strings attached. The key thing for investors to remember is that it has a deadline.
For both Canada and the US, the last day for tax-loss selling in 2019 is December 31; however, investors should remember that in Canada the trade date must be no later than December 27 for processing time. Investors still hoping to take advantage of this strategy will have to make their trades soon as the deadline is less than two weeks away now.
Tax-loss selling: The flip side
On the flip side, investors should be aware that as tax-loss selling gets underway, opportunities also tend to open up for investors who have spent the year on the sidelines.
In her piece “How Bout Tax Loss Buying?,” Gwen Preston, publisher of the Resource Maven newsletter, explains that Canaccord Genuity (TSX:CF,OTC Pink:CCORF) has found that from mid-November to mid-December, S&P/TSX Composite Index (INDEXTSI:OSPTX) stocks down more than 15 percent year-to-date underperform the index by nearly 4 percent. However, from mid-December to mid-January, those same stocks outperform the index by 3.6 percent.
“That outperformance is on top of gains the TSX reliably generates over that time frame,” Preston states. “So instead of only seeing tax-loss selling as a time to generate tax credits by dumping dogs, let’s look at the opportunity to profit.” You can watch her video on this topic below:
Tax-loss selling: How to time selling
Regardless of whether you’re buying or selling, Steve DiGregorio, portfolio manager at Canoe Financial, recommends that you act swiftly and aggressively as “liquidity will dry up.” DiGregorio earmarks the second and third week of December as the ideal window to sell or buy at a low point.
This is well ahead of the “Santa Claus rally” — the period around the last week of December when stocks tend to rise ahead of a healthier market in January.
For now, the year isn’t over yet, so whether you’re tax-loss selling or buying, there’s still time to talk to your accountant or financial advisor to determine which approach is best for you.
This is an updated version of an article first published by the Investing News Network in 2014.
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Securities Disclosure: I, Nicole Rashotte, hold no direct investment interest in any company mentioned in this article.