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Some tips on harvesting the losses in your RRSP

In March, 1991, gourmet Howard Schaeffer received a $1.1-million (U.S.) award from a New York City jury, which believed that a traffic accident had caused him to lose his senses of smell and taste.

And when Mr. Schaeffer was asked why he continued to weigh in at a very robust 250 pounds, he said he'd found other ways to enjoy food: "It's amazing how quickly you can get into texture."

Now there's a guy who has suffered losses but is making the best of the situation.

You may be able to do the same. I'm not talking about the study of food textures (but go ahead if that turns your crank).

I'm talking about making the best of a bad situation when you've suffered losses inside your registered retirement savings plan -- and who hasn't?
RRSP losses
The truth is, losses realized on investments inside your RRSP simply can't be claimed. But there's a strategy that can be implemented to effectively claim those losses. It's not for everyone, but where it makes sense it works wonders. Consider Suzanne.

Suzanne invested $20,000 in shares of XYZ Corp. inside her RRSP. Today, those shares are worth just $10,000. If Suzanne sells her XYZ shares in her RRSP, she won't be able to claim the loss. There may be a way, however, for Suzanne to receive some tax relief here. There are four steps in the process.

Step 1: Suzanne will write a cheque to her RRSP trustee for $10,000 (the current value of the XYZ shares), and will then withdraw the XYZ shares from her RRSP and will hold those shares outside her plan. This transaction can be considered a "swap" with the RRSP so that Suzanne doesn't use up any RRSP contribution room when transferring the cash to the plan, and there is no taxable withdrawal made when removing the XYZ shares. I wrote about RRSP swaps on Jan. 13, 2001, (visit to read that article). After this step, the XYZ shares held by Suzanne outside her RRSP will have an adjusted cost base of $10,000 (today's value).

Step 2: Suzanne likes the prospects of XYZ, so she will continue to hold those shares until they rise in value again to $20,000 (which would result in an accrued capital gain of $10,000). Sure, this could take some time -- but she's patient.

Step 3: When and if the XYZ shares rise to $20,000 again, Suzanne will then contribute half of those XYZ shares ($10,000 worth) to her RRSP as a contribution in-kind. She'll be entitled to an RRSP deduction for $10,000 assuming she has the contribution room, which will save her $4,500 in taxes at a marginal tax rate of 45 per cent. This contribution is also considered a disposition of half her XYZ shares, which will trigger a taxable capital gain. Don't forget, there will be an accrued gain of $10,000 on the XYZ shares, half of which is triggered in this step. So, a capital gain of $5,000 results. Suzanne's tax on this gain will be $1,125.

Step 4: Suzanne will then take the other half of the XYZ shares (worth $10,000) held outside her RRSP and will swap them into the RRSP in exchange for $10,000 cash. It won't count as a contribution to the RRSP, or as a withdrawal from the plan. This step does, however, trigger a taxable capital gain on this second half of the XYZ shares. So, another $5,000 gain is triggered, and a tax hit of $1,125 will result.

The bottom line? Suzanne will now have $10,000 of cash outside her RRSP, as she did before the strategy. And she'll own all her XYZ shares inside her RRSP as she did before the strategy. Her net tax savings will be $2,250 ($4,500 from the RRSP deduction less $1,125 in taxes from step 3 and $1,125 from step 4). How much tax relief would Suzanne have received had she been able to claim that $10,000 capital loss on her XYZ shares from the start? Right -- that same $2,250 that she has received under this strategy.
Final thoughts
Here are some things to keep in mind with this strategy:

You'll need a self-directed RRSP to enable an investment swap with your plan.

You'll need unused RRSP contribution room that you won't fully utilize in the future.

It's not necessary to invest in the same securities outside the RRSP as you held in the plan.

Suzanne could have sold those XYZ shares before or after completing the asset swap in step 1 and invested the money in other securities.

Even if your investments don't rise in value after the swap in step 1, you'll generally be no worse off than if you hadn't completed the strategy.
Tim Cestnick, CA, CFP, TEP is author of Winning the Tax Game 2002 and Winning the Estate Planning Game. He is managing director, Tax Smart Services, at AIC Ltd.

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