How do I use stock losses to lower my income taxes?

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By Julie Cazzin with Andrew Dobson

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Q: I lost half the price of my shares (a loss of roughly $5,000) and the brokerage sent me a report of the loss. Can this loss be used to lower taxes and how does that work? Can I lower taxes from previous years? Future years? How do I know what works best? — Charlie, Halifax

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FP Answers: Capital losses occur when you sell or are considered to have sold capital property for less than its adjusted cost base. In layperson’s terms, capital property generally includes securities such as stocks, bonds, mutual funds and exchange-traded funds, some of which may be sold at a loss rather than a profit, or capital gain.

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Capital gains are taxable and capital losses are deductible if securities are held outside a registered account. You cannot claim capital losses in accounts such as registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs) or registered education savings plans (RESPs), nor are the capital gains taxable. In your case, a $5,000 loss looks to have been triggered by the sale of securities in your non-registered investment account.

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Only 50 per cent of a capital gain is taxable and only 50 per cent of a capital loss is deductible on your tax return. The 50 per cent used to make these calculations is referred to as the inclusion rate.

Your $5,000 realized capital loss can be used to offset realized capital gains in the current year. If you don’t have any capital gains this year, or if you have more combined losses than gains this year, you have options.

You can claim the loss on any of your three previous tax years or in any future years. If you apply the loss to a previous year, it’s called a carryback and can be processed without filing a brand-new tax return.

To carry back losses, you file a T1A Request for Loss Carryback form as part of your tax filing for the year you realize the loss. Keep in mind the carryback does not affect your net income, nor does it affect benefits that are income tested for those years.

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To carry forward a loss, the Canada Revenue Agency (CRA) will record the carry forward and make a note on your annual notice of assessment until the loss is used. You can choose to use the loss against a future capital gain by claiming the loss on line 25300 of your tax return (net capital losses of other years).

Just because a loss carryback can be used to generate a tax refund in previous years doesn’t mean you should request the carryback simply because you can. Reviewing your overall tax situation over a period of time can be more effective in determining the value of the carryback.

For instance, if you anticipate being in a higher tax bracket in future years than one of the previous three years when you had taxable capital gains, it may make more sense to hold onto the net capital losses for future use.

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A good example may be if you own a rental property or cottage that you intend to sell in the near future, which will give you a huge spike in your income. You could carry forward the net capital loss and may save more tax than you could get refunded on a carryback to a previous year.

If you do not have any capital gains with which to offset your net capital losses during your lifetime, you may still be able to use these losses on your terminal tax year, which is your final tax return in the year you die.

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There is a special tax rule that allows individuals who have net capital losses to apply these against capital gains the same way you could in any other year, and be claimed against your other income in that year.

Keep in mind that to accomplish this, all net capital losses must be applied against capital gains in the year of death first, and if this still results in a net capital loss, these losses can be applied against capital gains realized in the three previous years. Only after applying the losses this way first can they then be used to offset other types of income on your final tax return.

There are a few strategies where capital losses can be tactically used to minimize tax during a specific tax year. The concept of tax-loss selling involves selling investments in the current year to offset the current year’s capital gains. If you have capital gains on other investments for the year, you could trigger losses on other securities to try to reduce your income and your tax for the year.

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In summary, there may be a way to recoup some of your loss, at least from a tax perspective, by saving tax or getting a refund on capital gains on a successful investment. Just be sure to consider whether to carry back or carry forward a loss to get the best bang for your buck.

Andrew Dobson is a fee-only, advice-only certified financial planner and chartered investment manager at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at [email protected].

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