Tax Loss Harvesting Revisited

No one likes to see their investments plummet in value, but it’s going to happen many times over your lifetime. If you’ve got a strategy for tax loss selling, you can make the best of the situation by harvesting capital losses that can be used to offset capital gains. That gives you an opportunity to reduce or defer taxes in the future, or even recover taxes you paid in past.

In a blog post on September 26, I noted that Canadian equities had fallen by about 5% since the beginning of the month, which could have triggered one such opportunity. (A useful rule of thumb, courtesy of Larry Swedroe, says a security should be sold when the loss is at least 5% and at least $5,000.) If you had recently made a large purchase of the Vanguard FTSE Canada All Cap (VCN), for example, you might have sold it that week to realize a capital loss and then repurchased the iShares Core S&P/TSX Capped Composite (XIC) or a comparable fund. As long as the replacement ETF tracks a different index you’ll maintain your exposure to Canadian stocks while also steering clear of the superficial loss rule.

I’ve written about this idea several times, but selling is only half the story. Remember, you can’t repurchase the original ETF for at least 30 days, and a lot of things can happen during that time. If markets recover swiftly, your replacement ETF will rise in value. So when you switch back to the original ETF you might end up locking in a capital gain that offsets your harvested loss, making the whole exercise an expensive waste of time.

Alternatively, markets could continue to fall over the next 30 days and allow you to harvest another loss when you switch back to the original ETF. As it turns out, that’s exactly what would have happened had you replaced VCN with XIC on the day of my original post.

Deeper down the rabbit hole

A trade on September 26 would have settled on October 1 (three business days later). You would have then needed to hold the replacement ETF until October 28, since a sale on that date would have settled October 31. (The 30 days between settlement dates would have allow you to avoid the superficial loss rule.) Here’s how the net asset value for both ETFs changed between the transaction dates:

Date VCN XIC
September 26 $30.25 $23.74
October 28 $29.43 $23.15
Change -2.70% -2.48%

As the Canadian equity market continued to fall in October, your opportunity for tax loss harvesting would have increased. Selling XIC on October 28 would have triggered another capital loss equivalent to about 2.5% of the holding. So if you started September with a $100,000 holding and locked in a $5,000 loss near the end of that month, you would have emerged 30 days later with over $7,000 in capital losses.

Of course, it’s not all wine and roses: your Canadian equity holding is still down more than 7% in two months. But that would have been true even if you had done nothing. As long as the markets move higher in the future—and we wouldn’t be investing if we didn’t expect that—you’ll be far better off if you were able to realize that loss before the recovery.

This just in from Justin

If you’d like to see a real-world example of a tax loss harvesting trade, visit Canadian Portfolio Manager, the brand new blog created by Justin Bender, my friend and colleague at PWL Capital. Justin harvested some losses for our clients by switching from one Dimensional fund to another in late September and then switching back last week. By doing so he was able to realize losses between $8,000 and $11,000 for the clients.

Justin’s new blog will feature insights into how he manages portfolios, and it includes a host of free resources including white papers, calculators, and ETF model portfolios. In the future, Justin and I will be collaborating on many articles and tools to help investors make better decisions. We’ve already got a long list of ideas, so stay tuned.

65 Responses to Tax Loss Harvesting Revisited

  1. Steve November 17, 2014 at 3:24 pm #

    @ Tyler:

    No worries, I made my peace with the temptations of the slippery slope to Couch Potato apostasy back when Nortel was The Big Thing – these days I take a perverse pleasure in having, more or less, the precise ACB of all our funds readily to hand while watching the markets gyrate insanely around them.

    It’s all sorta like an ex-smoker whose friends have ventured into the cold autumn rain for a puff, and he joins them just for the thrill of knowing he doesn’t have to 😉

    Btw I find it curious that you apparently trust Google Docs to correctly carry out all of its automated actions on your behalf, but not your brokerage to do the same. Sign of the times I guess.

  2. Canadian Couch Potato November 17, 2014 at 3:40 pm #

    @Dave Liggat: Capital gains and losses are always calculated in CAD terms for Canadian taxpayers. So currency fluctuations have the same effect as changes in the market price of the security.

    http://canadiancouchpotato.com/2013/04/04/calculating-your-adjusted-cost-base-with-etfs/ (see pages 13-14)
    http://canadiancouchpotato.com/2014/04/10/adjusted-cost-base-with-us-listed-etfs/

  3. Tyler November 17, 2014 at 6:30 pm #

    Steve: The more power someone has over me, the less I trust them. 🙂 So I definitely check up on my brokerage… if $100k worth of my money vanished overnight because of some glitch, I’d be a little concerned. For Google Docs, it’s not as if I have it placing trades automatically on my behalf or anything… worst case is I miss a harvesting opportunity or my portfolio is out of balance until I notice the problem (which I would probably pick up on while reviewing my brokerage statements, since they tell me what percentage of my portfolio each security represents).

  4. Willy November 21, 2014 at 10:27 am #

    Question – would switching from VUN (TSX.traded) to VTI (NYSE traded) be deemed a superficial loss?

  5. Canadian Couch Potato November 21, 2014 at 10:37 am #

    @Willy: That’s a great question. Remember, all we have to go on is the CRA’s bulletin of 2001, and that says two index funds tracking the same index are considered identical property. VUN and VTI track the same index, so by that definition they are identical property. I think we can all agree that these securities are quite different (traded in different currencies, domiciled in different countries, different fees) but all that matters is what CRA thinks.

    My guess is that at some point in the future this point will be challenged in court, probably by some scrappy DIY investor. That should lead to some clarification on an issue that has changed a lot since 2001.

  6. Willy November 21, 2014 at 11:10 am #

    Makes sense. Thanks for the quick reply.

  7. Oldie December 23, 2014 at 4:50 pm #

    @CCP: On July 21 I simplified my non-registered portfolio and bought a substantial amount of ZCN. I had previously (early 2013) already acquired a large batch of VCE, and it might have been more simple going forward to have bought more VCE, but firstly, Vanguard’s MER at this time was higher than the competition, and secondly I had an inkling of a possible strategy for reducing tax on a very large capital gain from 3 years ago. On November 14 the value of my ZCN had dropped somewhat from July’s value, so I sold the whole lot at a loss and bought VCN with the proceeds. (Vanguard had reduced the MER of VCN by this time, so it would have been a reasonable buy for the long term, and again, there was the off-chance of a further loss by the end of the year, so I did not spend the money to buy more VCE.)

    On December 16, the value of my VCN holdings had dropped significantly, so I sold the lot at a loss to re-purchase ZCN again with the proceeds. Interestingly, since this last exchange, the Canadian stock market has turned around, and my Canadian assets component has largely regained its value, but my tax losses have been successfully harvested.

    I just wanted to clarify, did I drop the ball at any time during this sequence? Would both the capital losses be valid and additive for tax purposes, given that I exchanged ZCN for VCN the first time and vice versa the second, and that there was 32 days’ interval between selling ZCN and re-acquiring it again?

    If I have managed to do this right, I thought I would bring up the point that in a situation where there would be a potential for future tax loss selling, purchasing additional shares of a previously bought asset (VCE in my case) would be counter productive in that any capital losses in a batch of newly bought shares would be “diluted” by the considerably lower prices of older shares. Therefore, a more fruitful strategy would be to look for a fresh pair of similar index funds of roughly the same class (VCN and ZCN in my case), but which track different indexes, and purchase within this fresh pair, in case a situation arises where one might exploit tax loss selling.

  8. Sesame March 14, 2015 at 1:25 pm #

    Thanks a lot for the very helpful website and information. May I ask if the tax loss harvesting can be applied to US- or European-listed ETFs (e.g. at Interactive Brokers)?

  9. Canadian Couch Potato March 14, 2015 at 10:25 pm #

    @Sesame: You can use tax-loss selling strategies with almost any type of investment that has the potential for capital gains and losses.

  10. Duane Storey August 5, 2015 at 1:33 pm #

    Doesn’t harvesting a tax-loss simply set you up for a larger capital gain in the future?

    Let’s say I have shares in ZCN with an ACB of $10,000, but it’s now worth $5,000. So I sell it, and I harvest that $5,000 capital loss and switch to VCN. But now I have $5,000 of VCN with an ACB of $5,000. If the ETF later goes back to $10,000, I now have a $5,000 capital gain, even though I’m right back where I started. Doesn’t that simply defeat the purpose of this exercise, since you’re simply turning a capital loss today into a capital gain later?

  11. Canadian Couch Potato August 5, 2015 at 2:47 pm #

    @Duane: In general, tax-loss harvesting should be thought of as a tax-deferral strategy, as it won’t always lead to overall tax saving. As you say, by resetting the ACB you are positioning yourself for larger capital gain later. However, in your example, your $5,000 capital gain on VCN could be offset with the carried-forward loss you harvested earlier when you sold ZCN, so you are no worse off than you were before. And you may be better off if you are able to use the loss to offset a capital gain you realized in a year when your marginal tax rate was higher, or if you can defer your taxable gains until retirement when you are presumably in a lower tax bracket than you are now.

    You might reasonably ask, “Why don’t I just hold everything until retirement and never realize any gains or losses?” The reason is that you will often be compelled to realize gains when you rebalance your portfolio, since this process often involves selling what has gone up in value. So harvesting losses when you have the opportunity gives you a “runway” you can use in the future when you do realize gains.

  12. Southpaw January 13, 2016 at 11:48 am #

    How about a partial identical property? I’m contemplating a switch from CPD to XPF which holds ~6% of CPD. Is this negligible enough to be considered exempt from the superficial loss rule?

    Thanks.

  13. Canadian Couch Potato January 13, 2016 at 11:55 am #

    @Southpaw: That would not be a superficial loss. Any two index funds tracking the same asset class will invariably have lots of overlap.

  14. Solanum tuberosum April 17, 2017 at 1:02 pm #

    Perhaps a silly questions, but is there such thing as a superficial gain?

    For example, if a person sells a ETF for a capital gain, but then buys back some of the same ETF within a short period of time. Thanks!

  15. Canadian Couch Potato April 17, 2017 at 1:53 pm #

    @Solanum: No such thing as a superficial gain. The CRA is quite happy to allow you to pay capital gains taxes now rather than deferring them!

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