Have you heard enough from me for now? To put the tips from my past two posts in context, I thought you might appreciate hearing some additional perspectives on how to implement tax-loss selling.
First, James Gauthier from Canadian robo-advisor Justwealth has been kind enough to share how they do things over at his firm. We’ll then hear from Shannon Bender, who will offer more insight into how we execute tax-loss selling in our PWL Toronto office.
Justwealth Tax-Loss Selling, by Chief Investment Officer James Gauthier
Thanks, Justin, for inviting me to contribute to the discussion on tax-loss selling … otherwise known as tax-loss harvesting.
What’s Your Frequency?
We think there are basically two approaches used for tax-loss harvesting: frequent or infrequent.
Frequent tax-loss harvesting is performed by an algorithm. It’s still relatively new, and we think it has a few drawbacks.
The rules used to trigger tax-loss harvesting trades are applied universally, and without interaction with clients. Tax-loss harvesting is either turned on, or it’s turned off. And everyone’s treated the exact same, regardless of their taxable position. Also, the outcome of tax-loss harvesting using this approach is completely unknown. You hope that the algorithm is going to work, but we would suggest that hoping and investment strategy typically don’t go too well together.
Infrequent tax-loss harvesting, by contrast, happens at a point in time, typically annually. The benefit of this approach is that the amount of tax-loss harvesting is known, and you can use this information to interact with clients, or their accountants, and decide on how this might impact their overall taxable situation for the year. For this reason, the annual tax-loss harvesting exercise typically occurs towards the end of the year when clients have a better sense of their annual taxable position. This is why the latter part of the year is sometimes referred to as “tax-loss harvesting season”.
Crossing the Threshold
We prefer the certainty and customization aspect of this approach, and are currently working on our annual process as we speak. We perform tax-loss harvesting on all non-registered accounts, but we do set a minimum loss threshold to make transactions material. We will adjust the threshold from year to year, based on how the market has performed. This year, we’re expecting the threshold to come in at around $1,000. We are also considering the inclusion of a 3% threshold, where we would only sell if the security was showing a loss of at least $1,000 and 3% of the book value.
To implement, we will perform a same-day swap, by selling the security with the tax loss and purchasing a similar but not identical substitute security, so that there’s virtually no disruption in market exposure. And once 30 days have passed, we will look to reverse the trades, avoiding any superficial loss.
In cases where the substitute security gains more in the 30 days than the actual loss that was realized, we will consult with clients on a one-to-one basis on how best to proceed. That’s pretty rare, but it does happen from time to time, and we could end up keeping the substitute security temporarily or indefinitely. So, it makes good sense to put the time and effort into making sure you have good substitute securities selected.
That’s a quick insight into our process. I hope everyone finds the information useful. And thanks again for inviting me to contribute.
PWL Capital in Toronto, by Portfolio Manager Shannon Bender
At PWL, we like to ground our tax-loss selling strategies in understanding as much as possible about each client’s tax status. This begins with running retirement projections, which gives us a better understanding of a client’s future tax rates. We also ask clients to authorize level 1 CRA access for us, so we can view (without changing) their:
• Net capital losses carrying forward
• Taxable capital gains from the prior three years
• Prior year’s tax returns (to help determine their tax bracket when offsetting prior taxable capital gains)
Tax-Loss Selling Is Always in Season
As Justin mentioned, we look for tax-loss selling opportunities year-round, not just in December, so we can realize losses that may no longer be available at year-end. To identify opportunities, we use in-house tax-loss selling software to generate a list of all taxable ETF positions showing a loss of at least $5,000 and 5% of book value.
Establishing Trigger Points
Justin also described why we use the combined $5,000 and 5% thresholds to manage upfront bid-ask spread costs. The software also enables us to adjust our thresholds to $10,000 and 10% if we’re planning a “round-trip” harvest – i.e., buying back the original ETF after 30 days. However, with our nearly identical tax loss selling pairs, there’s no need for us to switch back to the original ETF.
Avoiding Superficial Losses
Before we proceed with any trades, we also generate a transaction history for all family accounts – including corporations, trusts, RESPs, TFSAs, and RRSPs. We’re looking for any purchases of the target ETF that have occurred in the 30 calendar days prior to the settlement date of the proposed trade. If we identify any trades that could cause a full or partial superficial loss, we will decide on a case-by-case basis how best to deal with the issue.
For corporate accounts, we generally won’t engage in tax-loss selling, preferring to tax-gain harvest instead. Corporate tax-gain harvesting involves selling an ETF at a gain, thereby increasing the notional capital dividend account by half of the gain. Tax-free dividends can then be distributed to shareholders, up to the available balance in the capital dividend account. Depending on the shareholder’s personal tax rate, this can be a more tax-efficient strategy than distributing additional taxable dividends or salary. As this tax-gain harvesting strategy is complex, we would always recommend working with your accountant to determine whether it is appropriate for you.
Next Up: Planning Your Pairings
Last but not least, there are those tax-loss selling pairs we use to avoid violating the CRA’s superficial loss rules. Justin will dive into the details in his next post, and we’ll share our current list with you. Before we do, it’s worth mentioning that we regularly update our pairs whenever we spot better, newly launched substitute ETFs. For example, we recently changed VCN’s replacement ETF from XIC to the Franklin FTSE Canada All Cap Index ETF (FLCD).