There's no motivator quite like a deadline. And as 2005 comes to a close, a critical tax deadline looms tomorrow. This means that today is your last opportunity to examine the tax position of your investments to decide if it would be advantageous to sell any of your investments with accrued capital losses.
Capital losses realized in 2005 can be used to offset capital gains realized in 2005. To the extent your capital losses realized this year exceed your capital gains this year, the excess can be carried back up to three years to offset capital gains you might have reported in 2002, 2003 or 2004. This can allow you to recover taxes you might have paid in those prior years.
Now, in order for your capital losses to be realized in 2005, the settlement date for your trades must fall in 2005. The last trading date for settlement in 2005 is Dec. 23 -- tomorrow -- for Canadian stock exchanges, and Tuesday, Dec. 27, for U.S. exchanges. So, there's no time to waste.
By the way, does it always make sense to sell a security at a loss before year-end? I don't believe so. It makes sense to sell a security to trigger an accrued capital loss if you can meet one of two tests: (1) you have capital gains in the current year, or in one of the three prior years, against which to apply the loss (the "capital gains test"), or (2) you simply don't like the investment any more, or you see better opportunities in the market (the "better opportunities test").
But what if you have no capital gains to offset, and you still very much like the investment? Then hang on to that security. Let me show you why. Suppose you own shares in XYZ Corp. that you purchased for $30 but are trading at $20 today. You have no capital gains this year or in the past three years. You still like the XYZ shares as an investment. You decide, however, to trigger a loss anyway. So you sell XYZ for $20, triggering a $10 capital loss.
You still like the company and you reinvest the $20 into new XYZ shares, after waiting the compulsory 30 days.
The new shares have an adjusted cost base of $20. As it turns out, you were right about the prospects of the company, and the shares move from $20 to $30. If you then sell your new shares for $30, you'll have a $10 capital gain. You can then apply your $10 capital loss from the previous sale of your XYZ shares against that capital gain. The end result? You have $30 of proceeds (less transaction costs), and no tax to pay.
Compare this to a better option. Suppose you had just held onto your original XYZ shares without selling them for a loss. The shares had dropped to $20, but you still liked the company. If you had held those shares instead of selling them, you'd watch them move from $20 back up to $30, as in the previous example. Now, if you sell them at $30, you'll have $30 of proceeds, and no tax to pay (because your adjusted cost base is $30 on those original XYZ shares). You'd be in exactly the same situation as the first scenario, except that you'd save transaction costs.
Again, go ahead and sell those shares for a loss if you pass either the capital gains test or the better opportunities test, otherwise, the status quo may make the most sense.
Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.
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