Before rebalancing a portfolio for a new client, I make it a habit to confirm the Adjusted Cost Base (ACB) of any holdings in non-registered investment accounts. In knowing the ACB, I’m able to know the capital gain (or loss) that would be triggered and the associated tax liability (if any) of selling the portfolio. Now, we don’t want to let the ‘tax tail wag the dog’ so to speak; if the portfolio needs to be changed it needs to be changed. But if we can save taxes while doing so clients certainly appreciate it!
I recently came across a situation where using a little known strategy, I was able to do just that. Let’s call these clients Bob & Sue.
Sue is a high income earner (48% marginal tax rate) while Bob earns less and has a marginal tax rate of 20%. Sue has a non-registered investment account in her name only, with a capital gain position of $30k. Bob also has a non-registered investment account in his name with a capital loss position of $30k. The tax liability for the household ‘as is’ would be $4,200 as follows:
Sue: ($30,000 gain x 50%) x 48% = $7,200 owing.
Bob: ($30,000 loss x 50%) x 20% = $3,000 value of carrying loss forward.
If Sue had capital losses from previous years she could use them to offset her taxable capital gain. In this instance, she did not.
Bob has a capital loss which he can carry back three years, or carry forward indefinitely to offset gains in other years. However, being the lower income spouse the loss is less valuable to the household. This is where the strategy comes in.
Bob sells the securities in his account for $40k (with an ACB of $70k) incurring a capital loss of $30k. Sue immediately buys the same number of shares of the securities for $40k. This step triggers the superficial loss rule, which comes into play when a taxpayer sells securities at a loss, and the identical property is acquired by the taxpayer, their spouse, or a corporation controlled by the taxpayer or their spouse within a 61-day period around the sale (30 days before the sale and 30 days afterward). Under this rule Bob is denied use of the $30k loss, and the amount is added to the cost base of the securities purchased by Sue.
Sue’s cost base has now increased to $70k. She must hold the securities for at least 30 days, but can sell them any time after that. If we assume the share prices stay the same during that period, she will be able to declare a loss of $30k on the sale. This loss can be applied against the capital gains in her account thus eliminating the $4,200 tax liability for the household.
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While this wouldn’t apply to too many clients, it is an example of the types of strategy that we at TriDelta try to consider for all clients – wherever it can add value.