Market Rally: Proceeds of Tax Loss Selling?

You have to wonder with December 24th being the last day to sell Canadian stocks in order to be able to claim a capital loss for the 2008 tax year if the current multi-day winning streak is a true turning point, purely anomalous or perhaps the result of the proceeds of a lot of tax loss selling.

What Is Tax Loss Selling?

In a nutshell, if you sell a security that is trading at a loss from when you first purchased it you can sell it to realize the loss. You can carry forward this loss and apply it against future capital gains – net result is that you can reduce your tax bill by doing this. This all assumes we are talking about non-registered accounts. One further caveat is that you cannot just purchase the same security you sold the very next day – you have to either buy something different or wait 31 days to buy back the security you sold in order to be eligible to claim the loss. Further, in order to qualify for a certain calendar year your trade has to settle before the end of the year – that meant that December 24th was the last day to sell any securities at a loss and have it qualify for the 2008 tax year (since there were only three trading days after that, and trades take three days to settle!). For a more detailed explanation of tax loss selling, please read this article on the Million Dollar Journey.

Is It Just Money Looking For a Home?

With 2008 being such a dismal year, many people had planned on doing some tax loss selling (or tax loss harvesting as it’s also referred to). For those people, they may have planned on waiting to re-deploy their cash proceeds until the day after the last day for tax loss sales eligible for 2008 to take place, since in theory people would be selling right up until that point (the ones selling for tax purposes anyways). Selling pressure = more price declines so it makes sense to wait to buy until you think the selling pressure has subsided. Given that there is potentially a lot of money sitting on the sidelines, this shoot from the hip theory isn’t all that far fetched. Take a look at the chart to see the recent market action.

It’s worth noting that the price of oil has been on a tear as well, and since the TSX is so heavily swayed by the price of oil perhaps the timing of the last day for tax loss selling is just trivial. In either case, it’s worth noting that volume hasn’t been anything to write home about during this brief rally – which from a technical perspective indicates caution is warranted that this rally may be short lived.

What’s that? Forget trying to figure it out and just buy an index?

…bah! You’re singing to the choir. :)

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 10 comments
  • Mark Noble

    I was looking into this as well.

    A lot of analysts have been predicting a “January Effect” this year since there are huge amounts of tax-loss proceeds that can be redeployed.

    Risky and distressed asset classes typically get a bump as many fund managers get a clean slate to divert from their benchmark and try to place bets. (They have another 11 months to get back or or above their benchmark)

    The market performance can be very short-lived.

    My understanding is you have to wait until the end of the month before you can even consider to start assessing whether fundamental confidence is returning to the market.

  • Million Dollar Journey

    Another great article Preet. Thanks for the mention.

    When do you find out about the TV series?

  • Antony Pranata

    I am still a little bit confused with how capital loss is used to deduct our capital gain. It is mentioned that we cannot buy the same security within 30 days after we sold it. However, if we buy the same security, we can add it to the adjusted cost base of our next buy.

    From the amount money we can deduct, isn’t it just the same? For example:

    I bought shares of X at $5000.
    I sold it for a loss at $4000.

    It means I have capital loss of $1000.

    Then I buy shares X within 30 days after I sold it with the price of $3500.

    It means our new cost base for this transaction is $4500 ($3500 + $1000).

    If later, I sell the shares for $5500; my capital gain would be $1000 (instead of $2000). So, I need only to pay tax on $1000 gain.

    If I buy the same securities after 30 days, it means I get deductable from capital loss of $1000. Then later I need to pay for my capital gain of $2000. It other words, I only need to pay my capital gain of $1000.

    Aren’t they just the same? Am I missing something?

  • Thicken My Wallet

    Nothing has fundmentally changed between Dec. 31 and Jan. 1 to make me change my behavior of doing nothing and seeing which way the wind blows for a consistent period of time.

  • Preet

    @ Mark Noble – I would tend to agree with your conclusion – and that’s an interesting point about the time of the year for deploying funds into more exotic strategies – thanks for that!

  • Preet

    @ Million Dollar Journey – I believe they make the announcements this Friday. If I get it, I think Mr. Cheap should have to put on a dress and post a photo to Four Pillars. :)

  • Preet

    @ Thick – I think there may be a lot of “hope” out there that a new year automatically brings new fortunes…

  • Preet

    @ Antony – thanks for the question – I’ll write about it tonight as a separate post. Thanks!

  • Antony Pranata

    @Preet: Thanks. I am looking forward for the posting.

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