Tax loss harvesting

Tax loss harvesting, also known as tax loss selling, is the practice of selling shares (or units), held in a non-registered account, that have dropped in value to the point that a capital loss can be claimed (e.g., ). The capital loss can be used to offset capital gains, either in the current year or in the previous three tax years, or they can be carried forward to any future year. Tax loss harvesting tends to happen near the end of the year, although there is no specific requirement. Note that the loss must be calculated in Canadian dollars: when using securities traded in other currencies, such as US dollars, make you you actually have a loss in CAD, relative to your adjusted cost base in CAD, before you pull the trigger.

Timing and settlement
If you are tax loss harvesting near the end of the year, you should be aware of settlement dates and final trade dates.

Superficial loss rules
Canada Revenue Agency (CRA) rules specify that you or an affiliated person cannot buy back the security again within thirty (30) days or you will run afoul of CRA's superficial loss rules and the tax loss will be denied.

Transferring losses to your spouse
It is possible to use the superficial loss rules to transfer capital losses from one spouse to another to reduce their capital gains. This involves one spouse (Jack) selling a security at a capital loss and having the other spouse (Jill) purchase the same security within 30 days. Superficial loss rules will deny Jack the capital loss, but Jill's adjusted cost base is increased by the amount of the capital loss. As long as Jill doesn't sell the security within 30 days from the original transaction, the capital loss has effectively been transferred between spouses. It is important to note that the specific timing of the transactions matters here.

Replacing the sold security
To keep your asset allocation constant despite the tax loss harvesting, you can repurchase a very similar, but not identical, security immediately. For example, you can sell your shares in Canadian bank A and purchase shares in Canadian bank B with the proceeds. Or you can sell shares of an exchange-traded fund (ETF) covering Canadian equities and buy another ETF based on a slightly different index (see external links below for more details).

After the 30 day waiting period required to avoid a superficial loss, you can sell the replacement security and repurchase the original one. However, this will involve trading costs, and may generate taxable capital gains (depending on what has happened to the price of the replacement security during the waiting period). Therefore, if the replacement security is a very close equivalent to the original one -- especially in the case of ETF pairs --, there might be no reason to switch back.

Thresholds
Tax loss selling implies costs, in the form of commissions and bid-ask spreads. During times of high market volatility, the market can move against you during the few seconds or tens of seconds it takes to perform the switch. There is also additional book-keeping involved. Therefore, investors might want to decide on minimum thresholds above which they will engage in tax loss harvesting. These thresholds can be included in one's Investment Policy Statement for future reference.

Permanent replacement
For example, for a permanent replacement, Larry Swedroe recommends that the original security must show a minimum decline of $5000 and 5% relative to the adjusted cost base. The percentage loss was included in the rule because total bid-ask spread costs depend on the number of shares involved (or total security value). Other examples of rules are: DIY investors might adopt different personalized thresholds, as a function of their specific trading costs, tax rates, minimum acceptable tax savings, etc.
 * $1000 and 2.5%
 * $1000 and 3%

Temporary switch
The tax loss harvesting criteria should be more stringent if there is an intent to switch back to the original security after the end of the 30 day holding period, for example a minimum threshold of $10,000 and 10%. This is because more trading costs are involved in making a round-trip, and the replacement security might rise in price during the waiting period, partly or totally cancelling the loss that was triggered by selling the original security.

General advice

 * Norm Rothery in MoneySense, 3 tax-loss harvesting tips to remember

Tax loss harvesting with ETFs

 * Tax Loss Selling with Canadian ETFs | Canadian Couch Potato, October 2013
 * Finding the Perfect Pair for Tax Loss Selling | Canadian Couch Potato, October 2013
 * Tax Loss Harvesting Revisited | Canadian Couch Potato, November 2014
 * D. Bortolotti & J. bender, Tax Loss Selling Using Canadian-listed ETFs to defer taxes on capital gains, PWL Capital White Paper, October 2013
 * Canadian Portfolio Manager, Podcast 2: Dumping Your Losers – Tax-Loss Selling With ETFs, November 2019
 * Canadian Portfolio Manager blog, Part 1: Introducing Tax-Loss Selling, December 2019
 * Canadian Portfolio Manager blog, Part 2: When Should You Sell Your Losers?, December 2019
 * Canadian Portfolio Manager blog, Part 3: Two Takes on Tax-Loss Selling: Justwealth vs. PWL, December 2019
 * Canadian Portfolio Manager blog, Part 4: Which ETF Pairs Should I Use When Tax-Loss Selling?, December 2019