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The PWL Tax Loss Selling Report

It’s finally here! While many Canadians were gearing up for the much anticipated iPhone 6 launch, I was patiently awaiting an upcoming portfolio management software release: the PWL Tax Loss Selling Report.
PWL advisors can now generate a report that shows all non-registered client accounts that have unrealized capital losses. Any capital losses realized must first be used to offset capital gains realized in the current tax year; they can then be carried back up to three years (or carried forward indefinitely). This allows investors in relatively high marginal tax brackets to defer taxes and possibly realize them at a more advantageous time.

The report was inspired by Larry Swedroe’s tax loss selling rule of thumb. His rule states that an investor should consider realizing a loss if it is at least $5,000 and at least 5% of the book value.

For example, suppose Other Barry purchased the DFA Canadian Vector Equity Fund Class F (DFA600) for $70,730. On September 30, 2014, the fund had dropped in value to $65,342.53 (resulting in an unrealized capital loss of $5,387.47). This loss represents a 7.62% drop in the book value ($5,387.47 ÷ $70,730 = 7.62%). In this case, both of Swedroe’s tax loss selling thresholds have been met. The generated report will now include Mr. Barry’s holding as a potential tax loss selling candidate.

Canadian Portfolio Manager, Justin Bender

Source: PWL Capital

Know when to fold ‘em

The decision about whether to realize a capital loss depends on the investor’s particular tax situation (my colleague, Dan Bortolotti, wrote about this topic in a recent blog). Once the decision has been made to realize the loss, a replacement security must be chosen (in order to maintain similar market exposure). I would encourage advisors and DIY investors to have a tax loss selling plan in place prior to implementing their portfolios.

I’ve included the tax loss selling pairs below that we use with our PWL clients, as well as the monthly tracking errors of the underlying indices. As discussed in our white paper, Tax Loss Selling, tracking error is the standard deviation of the differences in the monthly returns of the underlying indices. A low value indicates that the indexes have tracked each other closely in the past.

Tax Loss Selling Pairs and Monthly Tracking Errors of Indices: 01/2004-12/2013

Initial Fund Replacement Fund Monthly Tracking Error
DFA Canadian Vector Equity Fund Class F (DFA600) Dimensional Canadian Vector Equity Index DFA Canadian Core Equity Fund Class F (DFA256) Dimensional Canadian Core Equity Index 0.364
Vanguard FTSE Canada All Cap Index ETF (VCN) FTSE Canada All Cap Index iShares Core S&P/TSX Capped Composite Index ETF (XIC) S&P/TSX Capped Composite Index 0.326
DFA US Vector Equity Fund Class F (DFA223) Dimensional US Vector Equity Index DFA US Core Equity Fund Class F (DFA293) Dimensional US Core Equity Index 0.772
Vanguard Total Stock Market ETF (VTI) CRSP US Total Market Index iShares Russell 3000 ETF (IWV) Russell 3000 Index 0.106
DFA International Vector Equity Fund Class F (DFA227) Dimensional International Vector Equity Index DFA International Core Equity Fund Class F (DFA295) Dimensional International Core Equity Index 0.347
Vanguard Total International Stock ETF (VXUS) FTSE Global All Cap ex US Index iShares Core MSCI Total International Stock ETF (IXUS)MSCI ACWI ex USA IMI 0.386

Sources: BlackRock, CRSP, FTSE, MSCI, Russell Investments, Vanguard Group, Morningstar Direct, Dimensional Returns 2.0

Suppose the advisor decides to realize the loss for Mr.Barry. He would place a trade to switch all units of the DFA Canadian Vector Equity Fund Class F (DFA600) to the DFA Canadian Core Equity Fund Class F (DFA256). The trade would settle on October 1 (trade date + 1 business days) and would need to be held for at least 30 days before it was switched back to the original holding (in order to avoid being deemed as a superficial loss). In this example, the replacement fund would need to be held by the investor from October 2 to October 31 (30 days). If the advisor switched back to the original fund on October 31, it would settle on November 3 (trade date + 1 business days), avoiding the superficial loss rules.  ***Note:  Most ETFs and stocks settle on T+3***


2 Responses to The PWL Tax Loss Selling Report

  1. Nik 14/02/2016 at 2:47 pm #

    Hi Justin,

    I have been reading about tax-loss harvesting, but I have never quite understood the real benefit. It seems you are simply deferring the tax that will inevitably be paid.

    However, if I am not mistaken, after considering it again, does the benefit arrive under the following circumstance: You defer capital gains in a year you are in a high tax bracket by harvesting losses, and then ideally when you actually do realize the gains you are in a lower bracket. Is it sort of like an RRSP in this way? The true benefit, assuming tax brackets stay the same, is that you are trying to realize the gain and pay taxes on it when you are in a lower bracket? Does this also mean that tax-loss harvesting is only useful in non-registered accounts?

    • Justin 16/02/2016 at 11:34 am #

      @Nik – tax loss selling is only relevant for non-registered accounts. The benefit that you mentioned (realizing the gains in a future lower income year), may be possible (and would lead to higher after-tax returns). Another benefit would be to have an interest free loan from the government (which you could use to invest and continue compounding).

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