Managing capital losses
Last chance for carryback opportunity
Despite the fact that a strong stock market recovery is fresh in our minds,
many individual holdings remain under water from their 2000 peaks. While fund
flows data clearly indicates that many investors gave up on some of their most
painful holdings, many people have stuck it through. For those who finally
crystallized some of their bear market losses last year, carrying back any net
capital losses can be a smart tax manoeuvre - more so than in future years.
Carry over provisions
Net capital losses arising in any year can be carried back three tax years,
or carried forward indefinitely. Itís important to note that all gains and
losses must be netted out to determine if an individual has realized, on balance
for the year, a net gain or loss. The ability to carry over net losses to other
years is only possible if a net loss is calculated for a particular year.
Also, check the notice of assessment provided after filing each yearís tax
return. Usually, any capital losses available for carry over to other years are
noted in the text portion of the assessment. Further, note that capital losses
are only deductible against capital gains.
Since inclusion rates and allowable portions of capital gains and losses,
respectively, have varied over the years carrying losses over to other years
requires an adjustment. Letís say an individual realized net losses in 2001 and
wanted to them back. The losses could be carried as far back as the 1998 tax
year. In 2001, half of capital losses were allowable as a deduction against
capital gains. In 1998, the allowable portion was three-quarters.
If that loss is instead carried forward, only half of the total loss will be
allowable. However, carrying the loss back to 1998 will allow three-quarters of
the loss to be used since 3/4 of net gains in that year were taxable.
The strategy that effectively expires with the filing of 2003 tax returns
should become clear at this point. Net losses realized in 2003 can be carried
back to the 2000 tax year. The year 2000 was confusing - not only for the
challenge many thought it would bring to computers around the world, but because
of the three rates of allowable capital losses. It began with 3/4 of gains being
taxable - and the same proportion of losses being allowed as deductions. The
February budget dropped that to 2/3 and the October 2000 mini-budget changed the
rate again to todayís figure of half.
The result was a rather confusing computation that sort of averaged the rate
depending on gain and loss activity in each of three specified time periods
within the year. Notices of assessment from 2000 tax returns list the effective
capital gains inclusion rate. The result is that the vast majority of
individuals who reported realized capital gains in 2000 ended up paying tax on
well over half of the total gains. That means net losses realized in subsequent
years could be carried back to years where higher rates of taxation applied to
capital gains. Also, tax rates in general have been trending down, thereby
creating incrementally more potential tax savings.
The year 2000 is the last year that capital gains inclusion rates exceeded 50
percent. 2003 was the last year in which net losses may be realized to
facilitate a carryback to the year 2000.
T1A Request for Loss Carryback is required to implement this strategy.
Dan Hallett, CFA, CFP is the President of
Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as
Investment Counsel in Ontario and provides independent investment research to
financial advisors. He can be reached at