Tax-loss selling (or tax-loss harvesting) is a strategy for lowering your Canadian capital gains tax that involves selling a security at a loss in order to offset your capital gains. You can then deduct these losses against your taxable capital gains in the current tax year.

For example, December 24 is the 2009 deadline for tax-loss selling on the Toronto Stock Exchange. If you sell at a loss on or before that date, you could deduct your loss against your 2009 capital gains. However, you can also carry your loss back for the three previous years (2008, 2007 and 2006), or carry it forward indefinitely to offset past or future capital gains.

Beware of the “superficial loss rule” when using tax-loss selling to lower your Canadian capital gains tax

If you are considering making use of tax-loss selling to minimize capital gains, you should be aware of the “superficial loss rule.” This rule states that if you, your spouse or a company you control buys back a stock or mutual fund within 30 days of selling it, you are not permitted to claim the capital loss for tax purposes. If you fail to obey the 30-day rule, your capital loss will be disallowed.

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However, there are some ways to maintain stock-market exposure during the 30-day period. For example, if you decide to sell resource shares that you bought at their 2008 highs in order to realize a capital loss, but then you decide that resource stocks are poised to rise further, you can buy a resource-heavy mutual fund to keep yourself exposed to that sector. Or you could buy shares in a company that is in a similar business as the one you sold (such as TransCanada Corp. and Canadian Utilities).

Canadian capital gains tax should be a secondary consideration when deciding whether to sell stocks

It’s always a good time to sell bad stocks, or stocks that are wrong for your portfolio. But you need to balance that rule against the fact that in the final couple of months of the year, some investors dump stocks without thinking, just to cut their taxes. In some cases, they simply want to sell and be done with it. In others, they intend to buy the stock back after 30 days (but as we mentioned, if you buy back any sooner, you cannot deduct your loss.)

As a result, stocks that have been weak tend to stay weak in the final month or two of the year. But the best of the bunch can put on extraordinary recoveries when tax-loss selling season ends.

Our advice: don’t let tax considerations spur you to make a costly mistake. You can always sell next year and carry your loss back.

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