Managed Money Reporter Newsletter — Issue 177, November 2001


Editors: Carl Spiess & Allan McGlade


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Tax Strategy for your Investment Account (non-RRSP)

Chances are, if you have invested in the equity markets during the past three years, you may be holding a few positions that are currently in a loss position. This is especially true when considering the effect the events of the last few months have had on the markets. While we continue to subscribe to the practice of buying and holding for the long-term, there are times when triggering a loss for tax purposes makes sense. The key is to trigger the loss without losing sight of your long-term goals. Keep in mind this only applies to your non-RRSP investments.

There are two scenarios by which selling at a loss makes sense:

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Scenario #1
Selling a security that does not appear to have good prospects for the future.

Unfortunately, your account may hold a couple of these types of securities. You know the ones we're referring to, that great tech stock you heard from a friend or a ‘hot stock tip' that was floating around. A company that was going to revolutionize the way we live and had made great profits for your newly ‘day trading' friends so far. Now, with venture capital financing all but dried up and not enough sales to generate a profit, the stock has plummeted. In retrospect, you probably should have never bought the stock in the first place and hopefully you have learned a valuable lesson at minimal cost. The best course of action for this situation in most cases is to cut your losses whether or not you can immediately apply them against capital gains.

Scenario #2
Good investment - rough market

In this strategy, you would be selling an investment that has great potential and is high quality, often blue chip stocks or medium to high risk mutual funds that have just had a tough run over the last few years due to market conditions. These investments are ideal to hold for the long-term, but if you don't have any ‘scenario 1' positions, this may be your best tax savings option for triggering a loss. Why sell? Why not wait for them to turn around? Simple. If you or your spouse had paid capital gains tax in the past three years, you may be able to get that money back - now that's the kind of ‘sure thing' that we like! Here's how it works:

If you trigger a capital loss, Canada Customs and Revenue Agency (CCRA) allows you to carry forward the loss indefinitely or back to the previous three years. Capital gains inclusion rates were higher than today's rates for most of 2000, all of 1999 and 1998. Therefore, taking this into consideration along with the fact that tax rates were higher in the past, it makes sense to try and get that back from the government. If you like the company or mutual fund and you want to buy it back that is always an option.

**Important**

When you sell a security at a loss, you or your spouse cannot buy it back within the 30 days before or after the disposition. If you do, it is considered a superficial loss and revenue Canada will not recognize it.

If you decide to trigger the loss, there are a couple of factors to consider before proceeding. What is it going to cost you to buy and sell the position and is it going to be more than you will get back? Stocks have commissions attached to transactions and mutual funds may have DSC (deferred sales charges) that you could incur. It's important to investigate these costs before proceeding. Another consideration is if you are willing to risk the value of the stock or mutual fund increasing while you are not holding the position, and missing that potential growth period. Also, note that in Scenario #1, you don't want to hold the security anyway, so the buy back rules don't apply.

The Easy Way 

With many mutual funds it is possible to trigger a loss without necessarily getting out of the mutual fund (unless of course you want to). Several of the fund companies offer corporate class funds (more tax-efficient) or an RRSP eligible version of the same fund you may hold. Switches between funds sometimes have restrictions, but we can evaluate them for you before you make a decision.

Tax Loss Example - How this works 

We have used the Elliott and Page Equity Fund in the chart below as an example for tax loss selling. The reason we chose this fund was due to the high distribution paid in 2000 of $5 per unit. Many investors that owned the fund in a non-registered account paid a significant amount of tax in 2000. The Elliott and Page Equity Fund had strong returns between 1998 and 2000 which was reflected in the increase in value over the two year period (see chart - total account value column). With trading and taking profits in 2000, Elliott and Page triggered capital gains for its unitholders. When the proceeds of these sales were reinvested and the market dropped this year, investors were faced with a difficult situation. They had paid considerable tax in 2000, followed by a substantial decrease in value this year. How can the decrease work to the unitholders advantage? By selling or switching to another fund within the same company. This will trigger a loss and offset those gains that they paid tax on. You can see from the example below that there were total taxable gains of $4,971 from 1999 and 2000 that the investor would have paid tax on. By placing the sale in September the client would have triggered a loss of $3,173. The investor can then use this loss to offset the previous gain they paid tax on in 2000 and reduce taxes by approx. $1,000 for the 2001 tax year.

The client's average return on investment over the past 3 years totaled 5.7% per year. Considering where markets are right now this is much better than some of its competitors for the short-term and much better than one would assume looking at an average cost price of $11.28 and a current price of $8.89.

It's important to note for this example that you cannot repurchase or switch back into this particular fund as it is capped for new purchases. However, the Sector Rotation Fund that E&P offers has a similar investment portfolio and the same manager as the Equity fund.

Tax loss selling has long been a strategy practiced by the pros in the investment business. In certain situations it can work very well for the private investor. We would be happy to discuss whether this is a strategy you should be employing for the 2001 tax year with you and/or your tax advisor.

This publication should not be construed as direct tax advice. Please note that as individual situations differ, tax strategies should be discussed with your tax professional before proceeding.

 



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E. carl.spiess@scotiawealth.com
    allan.mcglade@scotiawealth.com

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