In my previous blog, accompanied by Justin’s video tutorial, we looked at tax-loss harvesting, and more specifically, how to stay on the right side of the superficial loss rule.
A quick recap: effective tax-loss harvesting with ETFs involves selling a fund to realize a capital loss and immediately replacing it with a similar fund that would not be considered “identical property.” According to the Canada Revenue Agency, two index ETFs are identical property if they track the same benchmark.
So, if you sell the iShares Core S&P/TSX Capped Composite Index ETF (XIC) to harvest a loss and replace it with the BMO S&P/TSX Capped Composite Index ETF (ZCN) your loss would be deemed “superficial,” and you would not be able to use it to reduce capital gains.
Fortunately, the choices available to Canadian investors these days are richer than ever. That makes it relatively easy to find a replacement ETF that gives you exposure to the same asset class via a different index benchmark.
There are some important details to consider here. For example, if you sell an ETF that tracks the total U.S. market, you could replace it with another that tracks the S&P 500. But this is not an ideal pairing, since your original ETF included more than 3,000 large, mid and small cap stocks, while your replacement includes just 500 large caps. A better solution is to find a replacement ETF that also tracks the broad market, but using a different index.
Here’s another example of how you can tripped up by subtle differences. Say you’re using the iShares Core MSCI EAFE IMI Index ETF (XEF) to get exposure to international developed markets. A reasonable replacement for this fund might be the Vanguard FTSE Developed All Cap ex North America Index ETF (VIU), since both funds track the broad market in developed countries outside North America. But these are not ideal partners either.
The index providers MSCI and FTSE disagree about how certain countries should be classified. The most significant is South Korea, which is considered a developed market by FTSE, but an emerging market by MSCI. That means South Korea makes up about 5% of VIU, but you won’t find any Korean stocks in XEF.
As you would expect, the opposite issue arises with emerging markets ETFs. The iShares Core MSCI Emerging Markets IMI Index ETF (XEC) assigns more than 12% to South Korea, while the Vanguard FTSE Emerging Markets All Cap Index ETF (VEE) has no allocation at all.
Now, you can get around the problem by doing a double switch: in other words, by selling both XEF and XEC, and then replacing them with both VIU and VEE, or vice-versa. But that will only work if both ETFs are showing losses large enough to harvest. So it’s better to have some options for making a one-for-one switch.
In the table below, we offer suggestions for tax-loss selling ETF pairs that will allow you to maintain similar exposure to the asset class while tracking a different index. In most cases, there’s no need to switch back to the original ETF after the 30-day waiting period is over, since the suggested replacements are likely to deliver very similar performance.
| Asset Class | If you sell… | Replace with… | Notes |
|---|---|---|---|
| Canadian Equities | iShares Core S&P/TSX Capped Composite Index ETF (XIC) or BMO S&P/TSX Capped Composite Index ETF (ZCN) | Vanguard FTSE Canada All Cap Index ETF (VCN) or Franklin FTSE Canada All Cap Index ETF (FLCD) | TD Canadian Equity Index ETF (TTP), which tracks the Solactive Canada Broad Market Index, could replace the funds in either column, though its tracking error may be higher. |
| US Equities | iShares Core S&P U.S. Total Market Index ETF (XUU) | Vanguard U.S. Total Market Index ETF (VUN) | Both ETFs track the broad US market and provide very similar exposure. |
| International Equities | iShares Core MSCI EAFE IMI Index ETF (XEF) | BMO MSCI EAFE Index ETF (ZEA) or TD International Equity Index ETF (TPE) | ZEA and TPE include large and mid caps only, while XEF tracks a broader index. All three funds (unlike VIU) exclude South Korea. |
| Emerging Markets | iShares Core MSCI Emerging Markets IMI Index ETF (XEC) | BMO MSCI Emerging Markets Index ETF (ZEM) | ZEM includes large and mid caps only, while XEC tracks a broader index. Both funds (unlike VEE) include South Korea. |
| International and Emerging Markets | iShares Core MSCI EAFE IMI Index ETF (XEF) and iShares Core MSCI Emerging Markets IMI Index ETF (XEC) | Vanguard FTSE Developed All Cap ex North America Index ETF (VIU) and Vanguard FTSE Emerging Markets All Cap Index ETF (VEE) | If your developed and emerging markets ETFs are both showing losses, you can replace both at the same time. Use either MSCI or FTSE indexes for both, not one of each. |
The horizons corporate class ETFs would also work, right? for example, HXT (benchmarked to S&P/TSX 60 Index **total return**) as a replacement for XIC (benchmarked to S&P/TSX 60 Index).
Thanks!
Thanks for this! Loss harvesting has been on my mind a lot lately. I’m curious about the all in one ETFs such as VGRO and VEQT. Is it possible to replace those with other all in one ETFs while avoiding the superficial loss designation?
Thanks for this, as always.
I recall reading this post:
https://www.canadianportfoliomanagerblog.com/part-4-which-etf-pairs-should-i-use-when-tax-loss-selling/
In it, Justin indicates that VCN and FLCD are a good tax-loss selling pair. He says that VCN follows the FTSE Canada All Cap Index, while FLCD follows the slightly different FTSE Canada All Cap *Domestic* Index. Clicking through to the Vanguard website just now, however, shows that VCN now follows the same Domestic version of the index as FLCD. Any clue when that change took effect?
And I answer my own question: “Data regarding the Vanguard FTSE Canada All Cap Index ETF reflects the FTSE Canada All Cap Index through June 21, 2020 and its domestic version, FTSE Canada All Cap Domestic Index, thereafter.”
I think I’m good from a tax perspective. Phew!
@Bjorn: Yes, as you note, FLCD changed its benchmark index in June, so FLCD and VCN are now “identical property” and can no longer be paired for tax-loss selling. This one snuck under our radar, too!
@Jacob: Yes, you could swap a Vanguard version for an iShares version: for example, VGRO for XGRO, or VEQT for XEQT, or vice-versa. The Vanguard and iShares ETFs track different underlying indexes, so there would be no issue with superficial losses.
@yous: I think you’re referring to swapping HXT for XIU (not XIC). Our understanding is that this switch would be allowed, but not because of the “total return” nature of one index: both track the S&P/TSX 60 Total Return Index, even if XIU doesn’t say that specifically. The material difference is that HXT is a corporate class fund:
https://www.manulifeim.com/retail/ca/en/viewpoints/tax-planning/superficial-losses
“If selling a mutual fund trust, consider purchasing the same fund structured as a mutual fund corporation (or vice versa). These would not be considered identical properties because the legal structure of each (trust vs. corporation) is different, providing different rights to each investor.”
Hi Dan, this reminds me of something similar I’ve been wondering for a while. Say you have one of the all-in-one solutions that you hold for 40 years and it becomes massive in a non registered account. Then at 70 or so you want to switch to VRIF. You’re not really changing the strategy much, you just want the fund to be structured in a way that it makes a reliable payout. Is there no way to avoid an enormous capital gain hit in a case like this? I assume there’s no way to argue that the funds should be equivalent, but it seems, if they’re balanced the same, to make the investor do the 4% rule every year themselves would be unnecessary. But I guess that would be the investor’s only real strategy?
Hi Dan,
Your recommendations are helpful in this post, however, can you help me understand why your recommendations for international developed and emerging in isolation are different from the last one?
@Chris S: Unfortunately, there’s no magic solution here. If you hold an investment for 40 years and defer all of the gains, you will eventually have to pay the tax. In most cases, you can do this by divesting gradually over many years in retirement, when you will be in a relatively low tax bracket.
@Jeffery: This is explained in the post.
Hi Dan,
I read it again, but dont’t fully get why its only beneficial to do both when losses are large enough.
Can you replace a hedged version of an ETF with and unhedged version of an ETF (or vice versa) and still be on the right side of the superficial loss rule?
@Jeffrey: OK, now I understand the specific question. Say you hold XEF and XEC, and XEF is showing a $10,000 loss, while XEC has a $2,000 gain. If you sell both, your capital loss would only be $8,000. There’s no point harvesting a gain at the same time if your goal is to crystallize losses for tax purposes. In this case, a better solution would be to sell XEF only, net the full $10,000 loss, and replace it with ZEA or TPE. You should not replace XEF with VIU here, or you would now have no Korea in your international holdings.
However, if both XEF and XEC were showing losses, then you could sell them both at the same time and replace them with VIU and VEE. (You could also replace them with ZEA and ZEM.)
In summary:
– XEF/ZEA plus XEC/ZEM = good
– VIU plus VEE = good
– XEF/ZEA plus VEE = doubles up on Korea
– VIU plus XEC/ZEM = no Korea
Hope this makes sense.
@Brian: Great question, and in my opinion the answer is yes. Usually these funds track different indexes. For example:
– XUS tracks the S&P 500
– XSP tracks the S&P 500 Hedged to Canadian Dollars Index
Am I safe to sell SUN at a loss and buy XEG to get my tax loss? I know that SUN is not an ETF but XEG is made up of about 25% SUN.
@Dennis: You are totally fine doing this. In fact, a common strategy for stock investors is to, for example, sell some bank stocks at a loss and then buy an ETF full of bank stocks.
Overlap is fine: in fact. it’s preferred. Remember, if you are doing a swap such as XIC for VCN you are effectively selling and rebuying almost all of the same stocks, since the underlying holdings are very similar. But this is still allowed, as the properties are not “identical.”
You mention the TD Canadian Equity ETF as a potential tax-loss selling pair for XIC or VCN. I’m trying to understand the methodology of the Solactive index. I’ve read through some of the index documents from Solactive. The benchmark statement calls it a “net total return index.” The methodology guideline document has a bunch of fancy mathematics to explain the index methodology. Is there an easy way to explain how this index/ETF differs from the FTSE and MSCI ones?
@Bjorn: The Solactive index is not materially different from the S&P and FTSE counterparts. It’s true the details can be complex, but here’s a simple process for learning the important details.
First, make sure the index is cap-weighted, which means the stocks are weighted by size, and not according to any active strategy. The Solactive index passes that test: “Eligible listings are weighted according to a free float market capitalization methodology.”
Then look at the breadth of the market that’s included. For example, does the index include only large cap stocks (such as the S&P/TSX 60 and the S&P 500), or large and mid-cap stocks (like the MSCI EAFE), or does it try to track the total market, including all but the smallest stocks? If you’re comparing two indexes, you can look at the number of holdings in each. For example, TTP (tracked by the Solactive index) holds 293 stocks, which is effectively the total Canadian market. That’s actually more stocks than either XIC or VCN, but the additional holdings are all very small.
Sometimes indexes have quirks that include or exclude specific stocks in surprising ways. For example, the original index tracked by VCN didn’t include Shopify or the Brookfield LPs because FTSE included these in their American index instead (that makes no sense, but has since been corrected). One easy way to check this is to review the top 10 or 20 holdings in the two ETFs you’re comparing. These should be the same, and if both indexes are cap-weighted, the allocation to each should also be very similar. If that’s the case, then any differences in the methodologies are likely to small and not very important.
Hope this helps.
Would swapping an asset allocation ETF for its underlying funds be acceptable? E.g., crystallizing a loss in VBAL and buying 60% VEQT plus 40% VAB?
@Moti: Yes, that’s perfectly acceptable.
Hello, little off topic, was wondering if you could address again all the chatter about bonds. There are some smart minds out their saying bonds are not the place to be with the federal government buying so much and the bottom will fall out.
Ray Dalio who has advocated up to 55 percent in his publicized “all weather portfolio “says no to cash and bonds. He is vague and just says diversify well?
What’s the worst case scenario for the bond market blowing up, I am sure a lot are wondering about this and the risk when bonds pay negative yields after inflation. Stay the course or are we in uncharted territory with federal government unlimited bond buying? I hear now the Canadian government is switched to long bonds because of the small Canadian market and they own 1/2 the bond market in Canada now? So confused. Thanks in advance.
Hi
Thank you sir for you work and analysis.
I don’t see why South Korea is such a problem.
Let’s say a portfolio is 34% XUU, 33% XIC, 20% XEF, 13% XEC
South Korea total exposition would be 1.63% 12.5% of XEC 13%.
If we use VIU to replace XEF south Korea total exposition would be 1.06% ( 5.3% of XEF 20%)
Let’s says someone sold XEF and buy VIU but keep XEC. The exposition to South Korea would be 2.69% (+1.06%). Would someone event notice on the performance (if we also consider correlation: it’s not like south korea would behave so differently than all the other country no?)
If someone sell XEC, buy VEE and keep XEF than is overall exposition would be 0% (-1.63% only). Would that impact long term return that much? I think someone can do worse thing than that.
Isn’t there any disadvantage to have a smaller fund like TPE that has less volume and maybe higher bid ask spread or to have funds that drop the smaller company?
Is my analysis flawed? Maybe I am wrong but I bet no Canadian would notice to have 0% or 1.5% or 3% exposition to South Korea over a 20+ years horizon. Most people portfolio is already different than VT weight anyway
Thank you.
@Mathieu: It’s true, the presence of absence of South Korea is a pretty minor issue in a diversified portfolio. Swapping XEF for VIU would hardly be a grave error, but if the point of tax-loss selling is to maintain the same market exposure then it is not ideal. In Justin’s analysis, there was significant tracking error between the two funds, and much less so between XEF and ZEA. It’s up to you whether you see this as important.
As for TPE, it has over $812M in assets, so it is not particularly small, and we can’t assume it will have a wider bid-ask spread than the alternatives.
If my income bracket is the lower one.. should I still fill the rrsp before getting a non-reg account?
Hi Dan,
What are my options if i currently hold the td eseries?
Also, no way to avoid superficial losses if i hold the us currency eseries tdb902 and tdb952 right?
Probably not many alternatives for mutual index funds, but even would like to know for switching to ETFs.
@chino: Not necessarily. An RRSP may not be appropriate for someone in the lowest tax bracket, especially if they expect to be in a higher tax bracket in the future (for example, someone very early in their career). A TFSA, however, would still be appropriate for those in the lowest tax bracket.
@Jeffery: You could switch to another family of bank index mutual funds, such as the RBC family. These track different indexes from the TD e-Series funds. If you’re switching from e-Series to ETFs, the Vanguard and iShares options above would all work. Just don’t switch to the TD ETFs.
Hi Dan,
Whats a reasonable substitute for VXC
@Jeffery: XAW would be ideal.
I just wanted to say thank you for taking your time in addressing everyone’s questions. Keep up the good work!!! Cheers
If you own VFV, can you swap for XUU or VUN?
@Jack: Yes. VFV tracks the S&P 500, while XUU and VUN track much broader indexes.
Hi CCP
Any thoughts on the massive 1 year tracking error seen on XUU (-1.52) and XAW (-2.07) ? Looking at XUH (the CAD hedged version of XUU) we see an even larger 1 year tracking error.
I’ve seen the comment that it’s at least partly due to Blackrock holding 4 different US index ETFs (ITOT, IVV, IJH, and IJR) inside XUU and XAW rather than just ITOT. So, that begs the question, why doesn’t Blackrock just use ITOT and nothing more?
In comparison to XUU, VUN’s tracking error is much more digestible and seems perfectly reasonable to my untrained eye.
As such, despite the lower MER for XUU (0.07 vs VUN’s 0.16), why would anyone make a first time purchase of XUU instead of VUN? FWIW, I was ready to pull the trigger on XUU until I read about the 1 year error.
@Jim R: You’ve hit on the issue: for reasons only iShares can explain, they chose not to simply hold ITOT and instead used a combination of large, mid and small cap ETFs (though ITOT is now about 42% of the fund). As a result, they did a poor job tracking their benchmark last year. Unfortunately, they can’t immediately fix this issue, because the unrealized gains on the underlying ETFs are very large, so selling them and switching to ITOT would result in large capital gains distributed to unitholders.
Tracking error can work in the other direction, too, so there’s no reason to expect it to always be negative. But I certainly agree it was a mistake on iShares’ part not to simply use ITOT as its only underlying holding.
Thanks for your direction. On the topic of tracking error for XUU. would it be more tax efficient with no tracking error to purchase ITOT in an RRSP USD account?
@Fred: Yes, as long as you can convert CAD to USD cheaply.
Having successfully harvested capital losses, does it now make sense to swap back FLCD.NE for VCN.TO? Both ETFs now track the same FTSE index so I believe capital gains would be a wash. FLCD is no longer on the TSX and lags performance.
FLCD YTD 24.95% MER .06% Yield 2.45% 2020 total return 4.09%
VCN YTD 25.68% MER .05% Yield 2.46% 2020 Total return 4.81%
Using Questrade’s platform I see a max sell fee of $9.95
@SAB: If you would be selling your current ETF with a gain (not a loss) then you can indeed switch back to your original choice. I tend to agree that, all other things being equal, it’s better to use larger, more frequently traded ETFs, which tend to track their indexes more tightly.
Thanks for all you do ! I will have a large capital gain from the sale of a rental property and would like to take advantage of this down market. Would selling VSB, VSC and VAB to purchase ZDB work for tax loss selling ? VCN and XAW for XEQT ? I’m worried about partial superficial losses. Thanks for your help
@Donna: None of the ETFs you have mentioned would be considered “identical property,” so you would be fine. The only time superficial losses would be triggered is if you sell and then repurchase two ETF that track the exact same index (for example, the S&P 500). That’s not the case for any of the funds you’ve listed.
I am looking at harvesting a loss from my TD eseries international fund and purchasing ishares xef. To me it looks they are tracking different indexes. I have reviewed the updated white paper regarding superficial loss rules and just want to be sure I am not purchasing an eft that would cause my loss to be denied.
TD uses Solactive GBS Developed Markets ex North America Large & Mid Cap CAD Index.
and
ishares xef uses MSCI EAFE® Investable Market Index.
Am I correct that this is indeed the case?
@Cameron: Yes, you are fine swapping these two funds for tax-loss harvesting.
Thanks Dan, I am also looking at switching from TD eseries U.S fund to Vanguard Vun. Any issue swapping out these two for tax-loss harvesting?
Hi, I’m new at this. I understand I can swap XEQT to VEQT and vice versa- I hold both funds, if I sell both and do switch to the other , will that be looked at as superficial loss? Similar question re: XGRO/VGRO and XBAL/VBAL ?
Can I swap these balanced/mixed portfolios for each other ?
thanks
@Ky: If you hold one asset allocation ETF from Vanguard or iShares, then you can replace it with the equivalent ETF from the other provider. For example, if you hold only VEQT, then you can replace it with XEQT. I might be under standing your question, but it sounds to me like you’re saying you hold both VEQT and XEQT (presumably in different accounts). If you sell VEQT and buy XEQT in one account, and then sell XEQT and buy VEQT in the other, then you could trigger a superficial loss. The key point is that you cannot sell and repurchase the same ETF with the 61-day window.
One practical solution here might be to consider BMO’s asset allocation ETFs as a third option. For example, selling VEQT and XEQT and replacing both with ZEQT would not trigger a superficial loss.
@Cameron: Any time you are considering two ETFs as tax-loss selling pair, simply look at the benchmark indexes for the two funds, which are published on the ETF’s webpage. The only time you will have a problem with superficial losses is if the two indexes are exactly the same, which is rare.
Thank so much for this. I would like to tax loss harvest my loss in VXUS. Would VEU be a good match? When I look at the webpage – under the HIstorical Volatility Measures – Benchmarks, one of the 2 benchmarks is the same. Is this too identical?
@Joanne: VEU and VXUS are not identical properties and would be an ideal pair for tax-loss selling.
Thank you Dan and Justin for this amazing resource! I just completed some tax-loss selling in my non-registered. I have held VXC in my non-registered for a while and have been wanting to rebalance but haven’t been able to because of the gains that have built up over the years (a good problem to have! :) So, every year I move some VXC into my TFSA and RRSP to slowly whittle down future gains, but of course I still have to pay tax on these in-kind transfers. My capital gains from this year’s TFSA/RRSP contribution are already at 3k….But then I noticed today that I had 5k in losses in VUN in my non-registered! So, I sold some of my remaining VXC which ended up unlocking an additional 2k in capital gains, then I sold my VUN which unlocked 5k in capital losses. I then used the proceeds from both the VXC and VUN sales to purchase XUU (US Total Stock Market), bringing my tax bill to zero since my 5k in capital losses will offset my 5k in capital gains. The one thing to note, because the markets have been so volatile lately, I suggest completing your transactions within minutes of each other so you don’t miss out on any potential high swings in the market. By the time I sold and bought back in, the market had already moved 0.07%. If I had waited any longer, I could have potentially bought back in at a much higher price, which could have made the overall tax savings pointless.
@bethany: Glad you found these resources helpful.
One important note: you describe selling VXC and VUN and then repurchasing XUU with the proceeds. Remember that VXC holds US and international/emerging markets stocks, while XUU holds only US stocks. So these trades have actually changed your market exposure significantly. When making tax-loss selling trades, it’s important to make sure you’re swapping apples for apples. You’ve swapped an apple and an orange for an apple.
Hi Dan. I asked Robb Engen this question:
“I have been thinking of selling VBAL which has taken losses and then buying VUN/XIC/XEF (60%) and ZAG (40%) which effectively replicates VBAL. I would like to trigger the capital losses in VBAL but want to be sure that superficial loss rules don’t trip me up. Will this work with CRA? It’s a non-registered margin account.”
I was concerned that even splitting into the 4 ETFs (in a 60/40 split) might be ruled superficial. He pointed me to your article above and suggested just selling VBAL and buying XBAL which is definitely the easier (and preferred by me – to avoid my having to do the rebalancing) option. I just wanted your second opinion that this will work (that there hasn’t been any CRA opinions/rulings against it since you first wrote this article).
Appreciate everything that you and Robb do for the investment community.