'Tis the season for mistletoe and holly, crowded shopping malls, Santa Claus -- and tax-loss selling.
Selling at a loss is not a topic to gladden the hearts of investors, especially in light of the slide in income trust values. But losses are something they need to address at this time of year.
Bill Lewenza, a 55-year-old personal financial planner with Clarica Financial Services in Windsor, Ont., has already done so. He sold 2,000 Nortel Networks Corp. shares at about $2.50 each from his non-registered brokerage account one day before the stock was consolidated on a one-for-10 basis on Dec. 1. The transaction left him with about a $13,000 capital loss as he had purchased the shares for about $9 apiece about three years ago.
He plans to apply that loss against the approximately $15,000 capital gain he made on the sale of an income property in Windsor last June, reducing the capital gain on which he will be taxed to just $2,000.
But that was not the only reason for the sale. Mr. Lewenza no longer buys the investment story with Nortel. In doing so, he escaped the trap that many investors fall into. Too many investors sell losers based only on tax considerations. They fail to take into account whether the investment makes sense any longer.
Keith Rosen, tax partner with the Toronto-based chartered accountancy firm, Stern Cohen LLP, warns that "it is all very well selling something for tax reasons, but it could be a disaster from a market perspective." You might want to kick yourself if the stock subsequently doubles but then again, you may want to kick yourself if you hang on to the stock and it falls off a cliff, he adds.
Remember, too, that the current top tax rate on capital gains in Ontario is 23.2 per cent.
Patricia Lovett-Reid, senior vice-president at TD Waterhouse Group Inc., echoes Mr. Rosen's warning. She describes tax-loss selling as "a legitimate strategy; it is an important strategy; and it is a time-sensitive strategy, but do it for the right reasons. Don't let taxes drive the investment decision." She says investors should analyze the potential tax-loss sale candidate on a one- to three-year time horizon to see if it makes sense to sell.
But before an investor even gets to that point, he needs to figure whether he will be in a net capital-loss or capital-gain position this year. Does the total of his realized losses exceed that of his realized gains? It is realized losses and gains that count, not those unrealized positions that have yet to be precipitated by an actual disposition.
If he does have a net-loss position, then he should look back over his records and see if he had an overall capital-gain position in any of the preceding three years. And if he did, he can apply the loss against that. Or he can hang on to the loss as it can be applied at any time up until the investor's death.
But what happens if the investor ends up in a net realized capital-gain position? In that case, he should check back to see if he has any loss carry forwards, which he could use to reduce the tax or eliminate the gain. With or without the use of loss carry forwards, if the investor is still exposed to tax on net gains realized in 2006, then the question becomes: Should he sell some holdings with accumulated losses on them to avoid paying tax or at least reduce the tax payable on those gains?
