In our previous article we went through the basics of tax loss selling; however by working with your spouse you may benefit from a few more strategies.
First, a few important rules should be noted.
The Canada revenue agency has a rule called the “attribution rule”. This rule can cause income on an asset transferred to another taxpayer to be assigned back to the transferor. In this case, we are referring to situations where the asset was transferred in the 30 days prior to the sale, or that the asset was sold within the 30 days after it was transferred. If the aforementioned scenario applies then the following will occur.
· Gains and income will be taxed in the hands.
· Losses will be deemed as “superficial losses” under the income tax act and will be denied as a capital loss. The same situation will occur if the identical asset is repurchased within the 30 day window from the date of sale.
Although it seems like you can’t benefit from tax loss selling by transferring property to your partner, there are a few ways you can still profit.
To illustrate these strategies let’s use an example.
Peter and Diane are married. Both Peter and Diane are investing in their non-registered account. Diane has had a fantastic year as one of the companies she owns was acquired and she has sold some of her shares for a $10,000.00 gain. Peter on the other hand suffered a large decline in his portfolio and is currently sitting on an unrealized loss of $10,000.00.
There are two options they can use to help reduce taxes payable on Diane’s taxable gain.
Firstly, Peter can sell his shares and realize the $10,000.00 loss. Within the 30 day window after the sale, Diane must repurchase the exact shares in her own account making Peters’ loss “superficial”. However, the caveat here is that Diane can now add the $10,000.00 loss to her own average cost base (This simply adds $10,000.00 back to Diane’s book value). The shares are now in Diane’s hands and can be sold for the same $10,000 loss. If neither Diane nor Peter repurchases the shares within the 30 day window after the sale it will be counted as a capital loss. Since Diane was the last to hold the asset she can now use this capital loss to counter her capital gain and save on the taxes!
The second strategy is a little more complex and involves the following steps.
· Peter can file an election with the CRA to transfer the shares to Diane at their fair market value thus disposing of the shares at a loss. However, since the shares are transferred to an affiliated person (spouse) the loss is deemed superficial and is added back to his wife’s cost basis.
· Diane can either buy the shares from Peter in cash, or to save from doing this, a promissory note between Peter and Diane can be drafted. The promissory note essentially loans the money to Diane (at the prescribed CRA interest rate). Within 30 days of the tax year on the promissory note, Diane must pay interest to Peter which he must declare as income.
· Lastly, the shares transferred to Diane must be held for at least 30 days, afterwards, they can be sold and Diane will realize the capital loss to counter her capital gains. (The capital loss will only apply if neither her nor Peter buys them back in the following 30 days).
As you can see the superficial loss strategy, if used effectively, can be used to your advantage to counter your spouses’ capital gains. Next tax year, analyze your portfolio and your spouse’s gains and losses; you may notice ways to save yourselves more taxes!