October has always been my favourite month of the year: the fall colours, apple picking, pumpkin spice lattes and, of course, a seemingly endless supply of Halloween treats, more of which seem to be consumed by various household members than actually distributed on Oct. 31. But it also means that year-end is, alas, nine short weeks away, which provides some opportunities for investors to do some tax planning, but only if you act soon.
Here are a few things to think about over the next couple of months, given that markets have hit all-time highs and you could be sitting on substantial accrued capital gains in your non-registered portfolio.
For starters, when’s the last time you took a close look at your portfolio to make sure you’re comfortable with its current asset allocation? If you haven’t looked in months, you may be pleasantly surprised to find that your equity allocation is significantly higher than you had originally targeted.
For example, let’s say your goal was to have a balanced portfolio of 70-per-cent equities and 30-per-cent bonds or fixed income. With equity markets soaring in recent months and bond markets down, you may find that equities now account for 80 per cent of your portfolio. If your long-term plan is to maintain a 70/30 mix, you might consider rebalancing your portfolio by selling some of your equities and buying more fixed income.
But that’s where some investors get stuck. They are reluctant to sell an investment that has performed well because they don’t want to pay the tax, a phenomenon known as the capital gains lock-in effect. But if you consider that, eventually, you (or your estate) will have to pay the tax, it often comes down to a timing difference — pay the tax now or later.
But, of course, that’s not necessarily the full story if you believe that your tax rate may be higher or lower in the future. This could happen due to personal circumstances or because the government decides to raise, or lower (haha), the tax rate itself.
If you anticipate that your tax rate will be substantially different in 2022, perhaps because you may have just started or returned to work in 2021, and thus had a lower income this year, you may wish to rebalance your portfolio in 2021 rather than waiting until 2022. Conversely, if you believe your tax rate will be lower next year, you should consider realizing those gains after Dec. 31.
Some investors, however, fear that the capital gains tax rate itself could be hiked, and, possibly, even before the end of this year. It wasn’t in the Liberal election platform, but some worry that, given the minority government, the NDP, which had a hike in the capital gains inclusion rate to 75 per cent in its playbook, may hold some sway over the Liberals in setting tax policy in the upcoming Parliament, which is set to resume on Nov. 22. An economic update could follow shortly thereafter, and, while such statements don’t traditionally contain tax measures, it’s possible that tax changes could be introduced well before a spring 2022 budget.
Indeed, the last time the capital gains inclusion rate was changed, it was done as part of finance minister Paul Martin’s economic statement presented in the House on Oct. 18, 2000, when the capital gains inclusion rate was lowered to 50 per cent (from 66.67 per cent), where it has remained to this day. The change was effective immediately, as of that date.
As a result, investors who fear an imminent increase in the inclusion rate may wish to consider rebalancing a portfolio by taking gains currently, thereby locking in a 50-per-cent inclusion rate. There are also more sophisticated tax strategies that could buy you some time if you’re unsure what could happen to the inclusion rate, including rolling your appreciated securities to a holding company on a tax-deferred basis, and then electing to recognize (or not recognize) the gain afterwards, depending on what happens to the rate in the months ahead.
If you happen to have the odd loser in your portfolio, you may wish to consider selling it before year-end to crystallize the capital loss, which can be used to offset capital gains you may have recognized during the year. Capital losses that cannot be currently used may either be carried back three years or carried forward indefinitely to offset net capital gains in other years.
In order for your loss to be immediately available for 2021 (or one of the prior three years), the settlement must take place in 2021. For 2021, the trade date must be no later than Dec. 29, to complete settlement by Dec. 31.
Of course, if you plan to repurchase a security you sold at a loss, beware of the “superficial loss” rules that apply when you sell property for a loss and buy it back within 30 days of the sale date. The rules apply if property is repurchased within 30 days and is still held on the 30th day by you or an “affiliated person,” including your spouse or partner, a corporation controlled by you or your spouse or partner, or a trust of which you or your spouse or partner is a majority beneficiary (such as your registered retirement savings plan or tax-free savings account).
Under the rules, your capital loss will be denied and added to the adjusted cost base (tax cost) of the repurchased security. That means any benefit of the capital loss could only be obtained when the repurchased security is ultimately sold.
Finally, an alternative to selling and realizing a capital gain in 2021 would be to consider gifting publicly-traded securities, including mutual funds and segregated funds, with accrued capital gains in kind to a registered charity or a foundation, including a donor-advised fund. This entitles you to a tax receipt for the fair market value of the security being donated and it eliminates the capital gains tax, too.