I can recall Halloween in 1989 and the story of a department store employee who was taking a break at the back of the store and decided to try on a Batman costume that he was planning to wear to a party that night. At that moment, a security guard came to ask for his help in catching a shoplifter.
Later, speaking to the local media, the guard said: "You should have seen that man's eyes when he looked back and saw Batman chasing him." Apparently the shoplifter just gave up when he saw the Caped Crusader.
Batman did his job. Disguises can be effective. Another disguise can work to your advantage from a tax point of view. I'm talking about disguising your capital losses as your spouse's. It could save you plenty in tax. Here's how it works.
Let's suppose that you've incurred capital losses on a certain investment. Capital losses, once realized, can be carried back up to three years or forward indefinitely to be applied against capital gains.
The sooner you can use up those losses the better because it's cash in your pocket.
Now, suppose that you don't have capital gains in the past three years, or this year, to apply your losses against, but your spouse does.
Why not transfer the capital losses to your spouse so that he or she can use them instead? It's entirely possible to do.
There are three steps to transferring capital losses to a spouse.
Sell your securities on the open market. Let's suppose that you purchased shares in XYZ Corp. for $100,000, but they are worth just $70,000 today. So, you have a $30,000 unrealized capital loss. You don't have capital gains sufficient to use up these losses. Also assume that your spouse did have capital gains in the past three years sufficient to absorb the losses. The first step is to sell the XYZ shares on the open market, realizing the $30,000 capital loss.
Your spouse will now buy back XYZ shares within 30 days. Assume your spouse buys back the same $70,000 worth of XYZ shares that you just sold. Two things happen from a tax perspective: First, the capital loss that you realized in Step 1 will now be denied. Why? Because the superficial loss rules in our tax law say that when you sell a security at a loss and then you, or someone affiliated with you (i.e. your spouse), acquires the same security in the 30-day period prior to or after your sale (a 61-day window), then your capital loss will be denied.
Second, the capital loss that was denied does not disappear forever. The taxman will give it back to you by adding this loss to the adjusted cost base (ACB) of the newly acquired shares. That is, the ACB of the newly acquired shares, in my example, will not be the $70,000 paid, but $100,000 (the $70,000 purchase price plus the $30,000 loss that was denied to you). This higher ACB will result in a lower capital gain or a higher capital loss later when the XYZ shares are ultimately sold.
Clear as mud? Don't worry – I know this is where it can get confusing. The taxman allows this "bump" in the ACB of the shares acquired under Step 2 because the intention is not to disallow the capital loss forever, but only until the shares are ultimately sold and not repurchased in such a short time. By the way, this is why it's called an "adjusted" cost base; your cost for tax purposes may not always exactly equal what you paid – there may be adjustments, as in this case.
Your spouse will sell the shares on the open market. Don't forget, the XYZ shares are worth $70,000, but your spouse's ACB is $100,000. When your spouse sells on the open market, he or she will realize a $30,000 capital loss that can now be used to apply against capital gains reported by him or her in the current year, or the three prior years, to save tax immediately. Note: This third step must take place after the 30th day following Step 1 when you've sold XYZ – otherwise the capital loss will be in your hands and not your spouse's.
To ensure this transfer of losses takes place in 2013, be sure to complete Step 1 on or before Nov. 22. This will allow time for Step 3 to take place and for that sale to settle in 2013.