Finding the silver tax lining in a market decline
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As you may have noticed, most of the stock and bond markets declined in value in 2022. In many cases, that’s a bit of an understatement.
But is there a way to take advantage of that fact to reduce your income tax bill? Yes, and better than that, you may be able to recover taxes you paid on net realized capital gains over the past three taxation years
Whenever you sell a fluctuating investment like a stock, bond, mutual fund or ETF in a non-registered investment account, you will almost always realize either a capital gain or capital loss. If your total realized gains in a calendar year exceed your net realized losses, then you pay tax on 50 per cent of those gains. Your marginal tax rate is then applied to the half of the gain that is included in your income.
You will have deduced that the tax rate applied to capital gains is only half of that applied to interest, employment or net self-employment income. Well done.
None of this applies to sales within an RRSP, RIF or TFSA, which are sheltered from tax. Nor does this apply to cashing in a deposit instrument, like a GIC. The interest paid on a GIC is fully taxable, and there is no capital gain or loss, except in the rare case when you sell it to a third party prior to maturity.
Many wise investors sold some investments in 2021 as market euphoria carried prices to unrealistically high levels. By doing so, they did the brilliant (yet rare) investment manoeuvre called ”selling high.” The downside to this is realizing net capital gains. Many of those investors found themselves paying tax on capital gains in 2021.
If the proceeds from those sales were immediately reinvested in almost any investment vehicle as we entered the new calendar year, those new investments have likely declined year-to-date. Therein lies the opportunity.
If an investor sells more investments at a loss than a gain in 2022, resulting in net realized capital losses for the year, those losses can be carried back to 2021, 2020 or 2019 to recover taxes paid on gains in any of those three years.
Yes, Virginia, there is a Santa Claus, but with a very limited gift bag. This is one of the only strategies by which you can actually recover taxes you paid in a previous year.
Attentive students will also have noted another opportunity — deferral of taxes. If you bought some new stocks on, say, Oct. 1, you may be up substantially. Since then, the Dow Jones is up 16 per cent, the S&P500 is up 10 per cent and the main Canadian stock index, the TSX, is up eight per cent.
If you were smart (or lucky) enough to have purchased around that time, you have some tidy profits. By continuing to hold those investments, at least until January 2023, you defer tax on those gains. Better yet, if you purchased good quality companies that continue to increase their profits over time, you may be able to hold those stocks for many years, thus deferring the tax for those many years.
That’s the other nice thing about capital gains… You only pay the tax when you realize the gain by selling.
Work this tax thinking into your investment and financial planning for a more efficient accumulation of wealth. Over the next couple of weeks, we will remind you of other tax planning strategies as we approach year-end.
Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the FP Canada™ Fellow (FCFP) Distinction, and repeatedly named a Top 50 Financial Advisor in Canada. He is a Senior Wealth Advisor and Portfolio Manager with Christianson Wealth Advisors at National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.
Personal finance columnist
David has been a practising financial planner and life advisor since 1982, specializing in helping clients identify and reach their most important goals, and then helping them manage all of their financial affairs, including investments.