Though humbling, taking losses can make sense
TIM CESTNICK
Saturday, March 31, 2001
I was humbled again this week -- not once, but twice. On the first occasion I found myself in a hotel gym in Calgary, running on the treadmill.
I had stepped up the pace to a neck-breaking five kilometres an hour (just enough to outpace the elderly man to my right) when I heard a familiar voice.
I glanced up at the TV in front of me, and there I was, talking about registered retirement savings plans on CBC's Money Weekly -- a show on which I appear each Saturday. As I listened, nodding in agreement with everything I was saying, the tough looking woman to my left grabbed the TV remote from my treadmill and changed the channel.
"I hate money shows," she growled.
"Uh, me too," I stuttered in terror. Hey, who am I to pick a fight with a woman wearing a tattoo on her back that says "Die Hard"? So, I finished my run watching WWF wrestling. Humbling.
On the second occasion, I was bragging to my father-in-law about how I bought Nortel at $31 recently. No sooner had I opened my mouth than Nortel announced weakened earnings expectations and the stock tumbled.
I've lost big bucks in just three weeks. Humbled again.
Have you been humbled by losses recently?
In my last article I talked about the importance of thinking twice before you trigger those losses this time of year.
Now, I want to talk about those circumstances where it can make sense to sell those losers today. There are four of these situations. Here they are:
1. You don't like the investment anymore.
Take a look at that loser investment in your portfolio that is causing you the grief.
The stock or mutual fund has dropped in value. At one time you felt good about the prospects of the stock or fund. How do you feel today about the future prospects of the investment?
If the fundamentals of the investment haven't changed, maybe you're still convinced the investment will rebound. If you're convinced, however, that the future is not bright, this is reason enough to sell today -- even at a loss. That capital loss could save you tax down the road.
2. You reported net capital gains in the past three years.
Remember, capital losses must first be applied against capital gains from the same year.
To the extent you've got excess capital losses, they can be carried back three years or forward indefinitely.
There's no harm in triggering losses today if you know you've got gains from a previous year that you can apply those losses against.
In fact, you'll save more tax by applying your losses to gains in 1999 or previous years than you will by carrying those losses into the future. Why? Because the capital gains inclusion rate was lowered in 2000.
Today, just 50 per cent of capital gains are taxable. So, if you trigger net capital losses in 2001, you'll save more tax by applying those losses against gains reported in 1998, 1999, or perhaps 2000.
3. You've got an alternative investment in mind.
Even where you like the future prospects of the investment you're holding, selling at a loss can still make sense where you can find a similar investment that you expect to rise in tandem with the loser you're holding. I was considering, for example, selling my Nortel shares for a loss, and then buying shares of Cisco Systems in place of my Nortel. If you believe these two stocks will move in tandem with each other, this could make sense.
You've got to be careful about selling your loser and then reacquiring the identical investment within 30 days. In this case, the superficial loss rules will deny use of the loss until you sell the newly acquired investment. Buying a similar investment (or buying the same investment inside your RRSP), however, will not cause a problem.
4. You don't mind waiting 30 days before reacquiring.
If you're confident about the future prospects of that investment that has dropped in value, you could sell it today, wait until 30 days have passed, and then reacquire the identical investment. This will trigger a capital loss that can be used to offset gains. This idea, however, takes a strong stomach and lots of testosterone.
You run the risk of selling at a loss today and having the investment rise in value between now and the reacquisition date, which will generally leave you worse off than if you had just held the investment.
You might also give consideration to transferring unrealized capital losses to your spouse if he or she will be able to use them sooner. My article dated May 24, 1997, details how this is done.
You can find the article at waterstreet.ca.
Tim Cestnick, CA, CFP, TEP is author of Winning The Estate Planning Game, Winning The Tax Game 2001, and is president of The WaterStreet Group Inc., a firm affiliated with the Berkshire Group of Companies. He can be reached by e-mail attim@waterstreet.ca |
