Recent market volatility may have caused you some sleepless nights over the past week as you checked your portfolio and watched it seesaw up and down. If you’re one of those investors who has seen certain stocks or mutual funds you own drop in value over the past week or so, there are a couple of tax ideas that may help you make the most of these recent declines. Both strategies, of course, are only applicable if you hold your portfolio in a non-registered account, rather than, say, an RRSP, RRIF or TFSA.
The first strategy — tax loss harvesting — is generally not discussed much until year end, but can be done at any time. It would generally only be applicable, however, if you bought your stock or mutual fund more recently, as chances are if you’ve held the position for a couple of years or more, you likely still have an accrued gain, despite suffering a recent setback.
Under the tax rules, capital losses may only be applied against capital gains. If you have no realized capital gains in the current year, the capital loss may be carried back and applied against any capital gains in the prior three years or may be carried forward indefinitely to offset future gains.
But don’t think of selling at a loss and then trying to immediately buy the security back again — you will fall afoul with the superficial loss rule. Generally, a superficial loss will occur if you dispose of an investment at a loss and the investment is then re-acquired either by you or an affiliated person within 30 days. The tax law defines an affiliated person to include, among others, your spouse or common-law partner as well as a corporation controlled by either of you or even your RRSP or TFSA.
The consequence of having a capital loss deemed superficial means that the loss cannot be used immediately, but rather must be added to the adjusted cost base of the investment, only to be recognized upon its ultimate disposition.
But what if you don’t have any accrued losses in your portfolio to harvest but you do have several positions that have dropped significantly in the past week, wiping out substantially all of your accrued gains?
If that’s the case, now may be the ideal time to visit the second strategy: making your non-deductible interest tax deductible. For example, let’s say you have a mortgage outstanding on your personal residence. Under Canadian tax law, you can’t deduct personal mortgage interest. If you were to borrow money to invest in the stock market, however, the interest expense on that loan would generally be tax deductible since you are borrowing money for the purpose of earning income.
If part of your portfolio has decreased in value such that you have zero or minimal gains, you may wish to consider selling those investments, paying off your mortgage (subject to any pre-payment penalty, if applicable) or other consumer debt, and then getting a secured line of credit on your home to immediately buy back the investments you just sold.
If the investments were in a loss position, the superficial loss rule would kick in to deny your loss. But if they are flat or have a minimal gain, now would be an ideal time to do the debt swap, making your interest fully tax deductible.