Finding Tax Losses Can Feel a Lot Like Finding Waldo
October 29, 2012 by Editor, InvestingForMe
Sometimes unfortunately hunting for income tax losses can feel more like a round of Finding Waldo and just as much fun where you’re never quite sure what exactly you’re looking for and where you should be looking. So, let’s try to simplify the game and figure out what you need to look for.
First, what do income tax losses look like?
For individuals, income tax losses most often refer to capital losses. For example, we’ve all heard of that old saying – Buy low, sell high. Well, capital losses are what you get when you do the opposite – Buy high, sell low!
In other words, in their simplest form, capital losses are what you end up with when you sell an investment for less than you paid. Let’s say you buy an investment for $100, sell it for $10 and lose $90. That lost $90 is called your capital losses.
What’s interesting about capital losses, however, is that you can actually use capital losses to help offset capital gains – past, present and future, and thereby pay less income tax. That’s right, in some cases you can actually make money from money you’ve lost. So that $90 you lost on that investment example above? It’s actually money in your pocket in the form of income tax savings, so be sure to keep track of it!
So, how can I make money from money I’ve lost?
Almost all investors lose money in their lifetime and most of us just want to forget about it. We don’t like to be reminded of our mistakes, but we shouldn’t ignore the income tax benefits those losses create. Yes, that’s right. Your capital losses can be used as a credit to lower taxable capital gains – past, present and future.
Example: Let’s say after losing $90 on that previous bad investment, you go and buy another investment for $100 and then sell it for $190. (All right! You just made $90!) So, how can you actually make money from all of this instead of just looking like you broke even? Here’s how:
- Now, that $90 profit is called a capital gain, and you’ll need to claim it on your income tax return and pay the Canada Revenue Agency (CRA) their share, that is, unless you have capital losses that can be used as a credit.
- If you were smart and kept track of that first investment’s capital loss, you can reduce the $90 capital gain by the $90 capital loss, bringing your net capital gain and your income tax payable to zero.
- However, what happens if you didn’t keep track of the losses? You end up paying taxes on the $90 capital gain.
So, the moral of this little investment story is simple: Take the time to keep track of all your investments, and next thing you know, if you play the Finding Waldo game right, your capital losses (even though we all hate think about them) can actually make you money.
Where should I look for my capital losses?
Nowadays most Canadians have their savings squirreled away in different types of accounts (TFSAs, RRSPs, RRIFs, taxable accounts, etc.) and invested in different investments (stocks, mutual funds, real estate, GICs, etc.), so you first need to know where to look for capital losses. Here are a few helpful hints:
- Ignore your tax-free (TFSA) and tax-deferred (RRSP, RRIF, etc.) accounts. You might have capital losses inside these types of accounts but they are worthless. Why? Well, the CRA will only let you claim capital losses when they occur in a taxable environment. So capital losses inside tax-free and tax-deferred accounts cannot be used.
- Even in a taxable environment, certain types of investments also can be ignored because they also cannot generate capital gains or losses. Some examples of these include
- Canadian cash (excluding collectable bills and coins)
- Regular, non-transferable GICs and Term Deposits
- Index-linked GICs (if held to maturity)
- Canada Savings Bonds
- Provincial Savings Bonds
- The following investment types, however, are where you want to look because these ones can generate capital gains and losses:
- Cash in a foreign currency
- Collections (jewelry, art, coins, stamps, etc.)
- Real estate (other than a personal residence)
- Stocks, mutual funds, exchange traded funds (ETFs), Private company shares, etc.
- Individual bonds (corporate and government)
- Gold and silver bars and coins
- Index-linked GICs (if sold prior to maturity)
- and a number of other investment types
Remember: For most of us capital losses will be found in our taxable investment accounts and will result from investments we’ve made in financial assets (i.e. common shares, mutual funds, ETFs, individual bonds, etc.).
Note: When you’re hunting for capital losses, don’t forget those old, seemingly worthless penny stock certificates in your safety deposit box or your brokerage accounts. Those shares that went to zero are as good as cash and can still be used to eliminate taxes on capital gains or to reclaim income tax already paid, so dig them out, dust them off, and cash them in!
So, I’ve found some losses, what now?
If you do uncover some investment losses then your next step is to gather your documentation together. Gather all the paperwork supporting your purchases and sales of the investment. These could include old certificates, account statements, purchase contracts, dividend reinvestment statements, cancelled cheques and receipts. To claim your losses in your income tax return the CRA asks that you be able to support all of your numbers with paper documents.
Note: Sometimes when a mutual fund investment goes from good to bad, the fund company will merge two or more mutual funds together. When this happens the name and number of units you own will change, so hold onto all notices received detailing the transformation of your investment, as you may need these when you calculate your capital losses.
To properly claim your capital losses you will need to find documentation for all of the following:
- the investment’s value at the time it was sold
- the amount of money you had invested, often called your Book Value, in the investment before you sold it
If your investment is worthless and/or cannot be sold, you still need to demonstrate this to the CRA. A copy of your current brokerage statement listing the investment at zero value may be sufficient. If the investment is not held in a brokerage account and you have the original certificate you can search for information on the shares by
- visiting Infomart – Predecessor and Defunct Companies
- asking your advisor to look up the company in their copy of FP Survey – Predecessor and Defunct, or
- visiting your local library and use their copy of the FP Survey – Predecessor and Defunct
Note: You can ask your brokerage firm for assistance in documenting the investment’s current market value (or lack of one). Ask them to confirm the investment’s current market value in writing. If they charge a fee for this service, ask your accountant if the fee can also be added to the investment’s capital loss.
Finally, decide how to maximize your capital loss benefits
Once you have established the amount of money invested, the amount received when the investment was sold, and gathered your supporting documents, you should sit down with your income tax advisor to discuss how to maximize the benefits of claiming the capital losses since there’s quite a bit of flexibility when it comes to applying the benefits of capital losses. For example, your capital losses can be applied to offset past, present or future capital gains in the following manner:
- used to reduce capital gains in your current income tax year
- applied against capital gains claimed in any of the 3 preceding income tax years, or
- carried forward and used to reduce capital gains in any future year
So, while making dumb investment choices and losing money is never fun, in a way it is inevitable when investing your savings. At some point most of us make mistakes. The Buy low, sell high method of investing is not a perfect and predictable science. So don’t hide your losses and try to pretend they never happened. Grab them, dust them off, document them, and cash them in with the CRA on your next income tax return.
Remember: Your capital losses are just like dollar bills sitting on the sidewalk. Are you going to pick them up and pocket them or are you going to ignore them and be all the poorer for it?