It hasn't been a great year for many of the major equity markets.
The S&P/TSX composite is down 4.6 per cent year-to-date, the Dow Jones industrial average is down 4.1 per cent, the S&P 500 is down 2.1 per cent, and the Russell 2000 is down 3.3 per cent. You get the picture.
So, you might have accrued capital losses in your portfolio. What are you going to do about it?
If you take the approach of two seniors from Germany who, in 2009, kidnapped their financial adviser for losing a lot of their money, you might end up in jail. No kidding. James Amburn, an American financial adviser living in Germany, was kidnapped for four days by two clients, aged 74 and 61, before he managed to send a message by fax to someone to rescue him. I don't recommend this approach.
Instead, why not make the most of a bad situation and use your capital losses to your advantage?
Here are a few tips to make the most of those losses.
Sell if you don't like an investment's prospects.
Just because an investment has dropped in value doesn't mean you should automatically sell it. But if you don't like the future prospects of the investment, there's no reason to continue holding it – take your losses and run.
By reinvesting in something that you believe has a better upside you may eventually use up those losses. If you happen to still like the investment that has declined in value, consider holding onto it.
If it rebounds then your loss will disappear and you may have saved transaction costs by not selling today.
Sell if you have capital gains to offset.
The fact is, capital losses can be applied to offset capital gains that you might have realized in the last three years, this year, or might realize in the future. If you sell an investment for a capital loss in 2015, you can carry those losses back to 2012, 2013 or 2014, which can allow you to recover some taxes you might have paid on capital gains in those years. Capital losses can be carried forward indefinitely until used up.
To carry losses back to a previous year, use Form T1A. It's generally a good idea to carry the losses back to the oldest year first, so that you don't lose the opportunity to offset the capital gains in that year.
Beware of the superficial loss rules.
These rules will deny your ability to claim a loss if you sell an investment at a loss and you, or someone affiliated with you (your spouse, or a corporation you control, for example; but not your children), purchases the same or an identical security in the period that begins 30 days prior to your sale, and ends 30 days after your sale (a 61-day window). If these rules apply you won't be able to claim your loss today. Rather, the loss is added to the adjusted cost base of the newly acquired securities, so that you'll have a smaller capital gain or larger capital loss later when you ultimately sell those securities. One last point here: You might consider re-investing in something similar, but not the same or an identical security. The taxman's view is that an "identical property" is one that is the same in all material respects, so that a prospective buyer would not have a preference for one as opposed to another.
Watch your asset allocation when selling.
By selling off an investment you might be changing the proportion of your portfolio that you hold in various asset classes (such as equities, fixed income, cash). Make sure you watch this allocation and maintain the allocation that suits your risk tolerance and financial objectives.
Transfer assets to your kids or parents.
If you want to realize a capital loss but like the future prospects of the investment and want to keep it in the family, consider gifting the investment to a child or parent. Children and parents are not considered to be "affiliated" with each other under our tax law so that your loss won't be denied if you give up ownership and they acquire it within 30 days. You might make a transfer to your kids as part of your overall estate planning where your aim is to give away some of what you have today so that you have less that can face tax and probate fees at the time of your death. I'll talk more about capital gains and losses in my next column.
Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.