Four Tips to Use Capital Loss to Reduce Taxes

Capital gains have a complex tax structure because of the nature of this income. A person who is neither employed nor doing business can also earn capital gain if they sell their car, house, jewelry, stocks, and mutual funds. Capital gains can be significant, running into thousands and millions of dollars or just a few hundred dollars. The capital gain is taxable only when it is realized (through the asset’s sale). You always want to sell your assets for a profit. However, you may have some assets that are accumulating losses. What if you could use these assets and realize a capital loss to offset the capital gain and reduce your taxable income? 

How Taxes Work for Capital Loss

Taxes apply to the net capital gain after deducting capital losses and other costs incurred in buying and selling the asset, such as commission and transfer fees. Capital loss can only be used to offset gain and not to offset income from business, employment, or any other source.

Like most losses, the Canada Revenue Agency (CRA) allows you to carry back capital loss for three years and forward them till eternity. Even if you sold an asset and incurred a capital loss, the CRA allows taxpayers to decide whether to use the capital loss and how much of it to offset capital gain. This freedom led to the tax loss harvesting strategy, where individuals and companies preserve their capital loss to use it in the future when they incur windfall capital gains.

However, the new capital gains tax rules changed the calculation of net gains and the implementation of a tax-loss selling strategy in 2024.

How to Make the Most of Capital Gain Changes in the 2024 Tax Year

Before the rule change, only 50% of the capital gain was included in an individual and a company’s taxable income. However, the new rule changed the inclusion rate to 66.67% on capital gains realized on or after June 25, 2024.

The new rule has divided the 2024 tax year into two periods:

• Period 1 for capital gains/losses realized before June 25, 2024 (P1)
• Period 2 for capital gains/losses realized on or after June 25, 2024 (P2)

It also altered them for individuals and companies.

• For individuals, capital gain above $250,000 realized in P2 will be subject to a 66.67% inclusion rate.
• For corporations, all capital gains realized in P2 will be subject to a 66.67% inclusion rate.

The higher inclusion rate means more capital gain will be added to taxable income and could significantly increase future tax bills, making the capital loss strategy even more critical.

You might wonder why you should realize a capital loss if you have made no capital gains this year or in the previous three years. If the asset is illiquid and you manage to find a buyer, you could sell it for a capital loss and use this loss to offset future capital gains.

4 Reasons Why You Might Want to Use Capital Losses in Future Tax Years

• Higher capital gain inclusion rate: Future capital gains above $250,000 will be subject to a 66.67% inclusion rate. You can use your accumulated capital loss to reduce your capital gain to $250,000 for that year to protect your higher gains from taxes.
• Terminal tax: You could consider accumulating capital losses for your terminal tax return filed by your estate executor after your demise. On death, all assets are deemed to be disposed to your heirs and could incur a significant capital gain above $250,000. For instance, the value of a house bought 20 years ago might have significantly appreciated. The accumulated capital loss could reduce the capital gain from the deemed disposition of the house.
• Reduce taxable income after death: Unused capital losses in the year of death may also be applied to offset other taxable income beyond capital gain. This is an exception to the capital gain rules.
• Alternative minimum tax: The CRA also introduced an alternative minimum tax (AMT), which is the minimum tax every individual should pay. However, the net capital gain calculation is complex in AMT as 100% capital gain and only 50% of capital loss is included for tax purposes. Individuals with no other income (business or employment) might want to save capital loss for AMT on future capital gains. 

Can the CRA Deny Capital Loss Realized?

While capital losses can help you offset capital gains, there could be instances where the CRA denies you the capital loss. It is termed “Superficial loss”. The superficial losses are incurred only to reduce the capital gain and save tax.  

The superficial loss rules apply if you or a “person affiliated” with you acquires an “identical property” or has the right to acquire the substituted property 30 days before or after you dispose of the property.

• Identical property is the same in all material respects, making a prospective buyer indifferent towards buying one over another.
• Affiliated persons include your spouse or common-law partner, a corporation or partnership controlled by you or your spouse/common-law partner, or a trust where you or your spouse are majority interest beneficiaries.

Let’s understand this with the help of an example. Jacob buys 10 shares of X company for $100 each and sells them at $80 each, incurring a capital loss of $200 ($20 per share x 10 shares). Ten days later, Jacob repurchases 100 shares of the same company for $85 and sells it for $150, incurring a capital gain of $6,500 ($65 per share x 100 shares). Jacob cannot deduct the $200 capital loss on his $6,500 capital gain as it will be considered a superficial loss incurred to save tax on future capital gain.

However, if Jacob had bought the same shares after 40 days of selling them, he could have used the $200 capital loss to offset the capital gain. Hence, when investing in stocks, consider the timing of buying and selling.

Capital Loss Works Differently For Canadian Private Corporations

Even Canadian private corporations can use capital losses to offset capital gains. However, they have the benefit of adding the tax-free portion of capital gain (33.33%) to the capital dividend account (CDA) and distributing that amount to shareholders tax-free. If a corporation uses capital loss, the CDA amount will decrease. If the company has planned to pay dividends on the CDA balance and the balance reduces, it will have to pay a 60% penalty on the excess capital paid out.

The separate Period 1 and Period 2 inclusion rates in the 2024 tax year will make CDA calculations more complicated.

Contact KSSP Partners LLP in Markham to Help You with Capital Loss Strategies

Capital loss rules are complicated but can bring significant tax savings if used correctly. A skilled accountant can help you calculate and time the use of capital losses to make the most of this tax benefit. To learn about how KSSP Partners LLP can provide you with the best accounting and tax expertise, contact us online, or by telephone at 289-554-5997.