Investment advice in Ontario - How You Can Turn Fund Losses into Tax Benefits

With the end of the year approaching, it’s an ideal time to review the performance of your investments — in particular, segregated fund holdings that have declined in value. This is a great way to ensure that you are using insurance to maximize your income tax benefits.

Because in Ontario fund performance sometimes results in a loss, depending on the markets in a given year, we need to ensure that we are receiving good investment advice and pay as much attention to our “sell” strategy as we did to the steps that originally led us to make those promising investments.

The end of the year is a good time to consider selling underperforming segregated funds. We may not be able to revive them, but the right strategy can help minimize taxes and give the holdings one last crack at doing some good for your portfolio returns.

One piece of good investment advice in Ontario is to consider if the proceeds from those funds can be used in more promising investments, this could be the time to sell at a loss to improve your year-end tax position for more income tax benefits.

More good investment advice in Ontario is to recognize the opportunity to ‘sell low’. By redeeming fund units (outside your registered plans such as Registered Retirement Savings Plans) for less than their original cost, you will create a capital loss that can be used to offset capital gains on your income tax return. By reducing your capital gains, you reduce your income tax bill.

You may even be able to use that loss towards income tax benefits by reducing income taxes in future or past years. If you own money-losing segregated funds that are likely to make a year-end distribution, you take advantage of the capital loss for income tax purposes and avoid a taxable distribution by redeeming before the distribution date (generally mid-December).

We need to carefully consider which of your segregated funds holdings are candidates for tax-loss selling. These should be investments that we believe have little opportunity for recovery. We also need to weigh the financial benefits of tax-loss selling in each case.

When we create a capital loss, it must first be used to offset any capital gains earned in the same income tax year. Any remaining losses can be carried forward indefinitely to future years or applied to gains from the previous three years.

Here’s an example of how tax-loss selling can work to your benefit.

Let’s assume you invested $80,000 in a segregated fund a few years ago (outside a registered plan) and sold that investment this year $100,000, for a profit of $20,000. You also sold a money-losing fund investment this year for a loss of $10,000. You would deduct the $10,000 loss from the $20,000 gain, leaving you with a capital gain of $10,000 for the year. Half that amount must be reported as a taxable capital gain on your income tax return, so you will pay tax on $5,000. You can use a capital loss on any eligible investment to offset a capital gain on any other eligible investment. For example, your segregated fund loss could be used to offset gains from segregated funds, stocks, bonds, exchange-traded funds, or even promising investments in real estate. However, capital losses can normally be used only to reduce or eliminate capital gains, not to offset other income.

There is one important caveat: When you sell a security to claim a capital loss, do not buy that security again for at least 30 days. Otherwise it will be deemed a superficial loss by the Canadian Revenue Agency and you won’t be allowed to use it to reduce taxable gains.

Timing is important. Transactions need to be completed before year-end to qualify for your 2011 income tax return. Please refer to your tax professional or accountant for advice.