Tax-loss harvesting is a concept that can sound counterintuitive at first. You intentionally sell investments at a loss, even though your clients would prefer to see every position in the green. But when it is used correctly in taxable accounts, this approach can help reduce taxes on capital gains and support long-term wealth-building for your clients.
In this article, Wealth Professional Canada will discuss what tax-loss harvesting is and how it works. We'll cover the rules you need to keep in mind and when it might be worth using for your clients. You can also browse the latest tax loss harvesting news when you scroll to the bottom of this article!
Tax-loss harvesting is a strategy where your clients sell investments in a non-registered account for less than their adjusted cost base (ACB). That sale creates a realized capital loss that can be used to offset realized capital gains.
The ACB is the total amount it took to acquire the investment. That usually includes the purchase price plus expenses such as commissions and legal fees. When an investment is sold for less than that total, the result is a capital loss. When it is sold for more than that total, the result is a capital gain.
When your clients realize losses in a non-registered account, those losses can offset gains from other investments that were sold for a profit in the same year. This can reduce, or sometimes even eliminate, the tax your clients would otherwise owe on capital gains.
Learn more about tax-loss harvesting when you watch this video:
Top financial advisors in Canada can use tax-loss harvesting to turn market losses into opportunities, cutting clients' tax bills while improving their after-tax returns.
Tax-loss harvesting is only relevant in accounts where capital gains are taxable. In Canada, that means non-registered investment accounts. Your clients might hold:
When these securities are held in non-registered accounts, gains and losses matter for tax purposes. That is where tax-loss harvesting can come in.
On the other hand, your clients' investments are not subject to capital gains tax in the same way if they are held in registered accounts like:
The Canada Revenue Agency (CRA) does not allow your clients to use capital losses inside these registered accounts to offset capital gains in non-registered accounts. As a result, tax-loss harvesting is not a strategy you can apply within registered plans.
In a year when your clients realize both gains and losses, the first step is to match capital losses against capital gains. If the allowable capital losses are greater than the taxable capital gains, the excess is called a net capital loss.
Net capital losses do not disappear. Your clients have three options:
For a financial advisor, this means a large realized loss in one year can provide tax benefits that extend far beyond that year. It can help reduce taxes on gains your clients realized in the recent past or gains they will realize down the road.
Tax-loss harvesting in Canada does not simply involve selling and rebuying whatever your clients want, whenever they want. The CRA has rules that determine when a loss is allowed and when it is considered superficial.
Understanding these rules is vital so that the trades you recommend can produce the tax result you and your clients expect:
The superficial loss rule is central to tax-loss harvesting in Canada. Its purpose is to prevent your clients from selling only for tax reasons while keeping the same investment in place.
A superficial loss happens when your client or an affiliated person:
If these conditions are met, the loss is considered superficial. It cannot be used to offset capital gains for that year. Instead, the amount of the superficial loss is added to the adjusted cost base of the newly acquired investment. The loss is effectively deferred into the future.
Because of this rule, your clients cannot sell a stock at a loss, buy it back a week later, and claim the loss right away. To use the loss in the current year, they need to wait at least 30 days before repurchasing that exact stock. They could also choose to move into a substitute that is not considered identical.
Trivia: The superficial loss rule is similar to what investors in the United States call the wash sale rule.
To stay invested while respecting the superficial loss rule, your clients can shift into a similar investment that is not considered identical. For example, they can:
The goal is to keep exposure to the desired asset class or market while still allowing the realized loss to be recognized for tax purposes.
As noted earlier, tax-loss harvesting only applies to non-registered accounts. Capital gains in registered accounts are already sheltered or deferred under their own rules. As such, there is no extra benefit from trying to harvest losses inside those accounts.
The CRA does not allow your clients to use a loss that arises in a registered account to offset a gain in a non-registered account. For that reason, any trades you consider for tax-loss harvesting should take place in taxable, non-registered portfolios.
Like other strategies for lowering your clients' tax bills, tax-loss harvesting has limits. As mentioned above, it is not available in registered accounts. So even if your clients experience declines in those accounts, those losses do not translate into capital losses for tax purposes.
There is also the risk of focusing only on taxes and ignoring investment quality. If your clients continue to buy into a declining asset without reviewing its fundamentals, harvesting losses could simply lead to repeated losses. A sound review of the investment case should come first.
Lastly, this strategy requires careful record-keeping. Factors like trade dates and holding periods all matter. Poor records can lead to incorrect gain and loss calculations that can create issues when filing tax returns.
Now that you know these tax-loss harvesting risks, you might want to check out other ways to legally pay less taxes in Canada:
Are the benefits of tax-loss harvesting too often overstated? Find out when you read this linked article.
Tax-loss harvesting can also support portfolio rebalancing. As markets move, your clients' portfolios drift away from their original mix of asset classes. Selling certain holdings to realize losses can create an opportunity to reset that mix. For instance, you might:
Throughout this process, adjusted cost base tracking remains important. Each purchase and sale affects the ACB of the remaining or new positions. In turn, this impacts the size of future gains and losses.
Tax-loss harvesting is not a magic fix for poor investments. If your clients own a security with weak fundamentals and limited prospects, tax savings alone are not a reason to hold on. At the same time, when used with care, tax-loss harvesting can improve after-tax outcomes over time.
For a financial advisor, the question is not whether tax-loss harvesting is always worth using, but when it makes sense and when it does not. Tax-loss harvesting is also not about chasing losses. It is about turning unavoidable downturns into something more constructive for your clients' long-term goals.
As always, it is wise to work alongside a tax professional when your clients are making tax-sensitive decisions. Together, you can help your clients realize when tax-loss harvesting is appropriate and how it fits into their overall financial plan.
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