Last month, Tizi Hodson, 70, from Lincolnshire, England, received a letter back that she had mailed 48 years ago. She had applied for her dream job as a motorcycle stunt rider, but her letter had been lost behind a post office drawer until this year.
Despite her immense disappointment not hearing back all those years ago, Ms. Hodson moved to South Africa, learned to fly, and became an aerobatic pilot and flying instructor. She clearly made the best of an unfortunate situation.
Investors can learn something from Ms. Hodson. When life hands you lemons, try making lemonade. If you’ve lost money in an investment, make the most of your capital losses. One way to do this might be to transfer your capital losses to your spouse.
The Idea
Perhaps you own an investment that has dropped in value, so you have an unrealized capital loss. Given the change this year to the capital-gains inclusion rate, you’ll save more tax if you apply those capital losses against capital gains realized on or after June 25, 2024.
It may also be the case that you don’t have capital gains after that date against which to offset your capital losses. But what if your spouse does? The good news is that it’s possible to transfer unrealized capital losses from one spouse to the other.
This can allow your spouse to use those capital losses against capital gains she realized this year, or in the future – or even to carry those capital losses back up to three years to 2023, 2022 or 2021 to recover taxes paid on gains in the past. But don’t be quick to carry capital losses back to prior years when capital gains were subject to lower rates of tax if your spouse has, or is likely to have, capital gains taxed at the higher two-thirds inclusion rate that kicked in this past June.
The Steps
This idea is extremely easy to implement. Consider an example where you purchased shares in XYZ Corp. for a cost of $50,000. Suppose also those shares are now trading at $10,000, so you have a $40,000 unrealized capital loss. Perhaps you don’t have capital gains to apply these losses against, but your spouse might have capital gains – particularly gains taxable at the new higher inclusion rate. It’s possible to transfer your $40,000 of unrealized capital losses to your spouse using three simple steps.
Step 1: You will sell your XYZ Corp. shares on the open market for their value of $10,000. You have now realized the $40,000 in capital losses. But since you can’t use the losses, we won’t stop at this step.
Step 2: Your spouse will then purchase the same number of XYZ Corp. shares on the open market shortly after you sell your shares. Let’s assume this costs your spouse $10,000. When your spouse buys these shares, the superficial loss rules in our tax law kick in and will deny you the use of your capital losses. These rules say that when you, or someone affiliated with you (like your spouse), purchase the same security within a window that is 30 days before or after the sale in Step 1, then your capital loss will be denied.
But does the capital loss disappear forever? No. Our tax law will take that capital loss and automatically add it to the adjusted cost base (ABC) of the new acquired securities. In our example, then, your spouse will have paid $10,000 for the XYZ shares, but their ACB will be increased by the $40,000 capital loss that was denied. So, your spouse’s ACB is actually $50,000 (the $10,000 cost amount plus the $40,000 capital loss that was denied). This brings us to the final step.
Step 3: Your spouse will now sell the XYZ Corp. shares for their value of $10,000. Since your spouse’s ACB is $50,000, your spouse will realize a capital loss of $40,000, which can be used to offset their capital gains.
The Details
You have to get the timing right here. Step 1 (the initial sale) will start a 30-day clock ticking. Step 2 (the repurchase) must take place before the 30th day after Step 1. This will cause the superficial loss rules to apply – which we want. Then, Step 3 (the second sale) must take place after the 30th day following Step 1. If you ignore this timing, the superficial loss rules won’t apply, and the idea won’t work.
Finally, if you want your spouse to realize the capital losses in 2024, Step 1 (the initial sale) will have to happen on or before Nov. 28, 2024, leaving time for the second sale (Step 3) to settle in 2024.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at tim@ourfamilyoffice.ca.