Triggering losses on bond holdings could have several benefits for investors, says BC-based portfolio manager
For most people, the season for tax-loss harvesting usually comes near the end of the year. But as one top advisor points out, it may make sense to consider executing the strategy even before that in some cases.
“People are most often talking about tax-loss selling in November and December, because of course, personal tax filings are made on a calendar-year basis,” says Kevin Burkett, portfolio manager at Burkett Asset Management in BC.
“If they feel like there are gains within their portfolio that could be offset by triggering losses, perhaps even from previous years, it’s a logical time for them to think about it.”
Tax-loss harvesting: a year-round strategy
According to Burkett, clients typically ask about tax-loss harvesting around the holidays. But as discretionary portfolio managers, he and others on his team constantly watch for opportunities to realize losses whenever they make investment decisions.
“We can be proactive in triggering losses at any time of the year. That’s especially important for clients who have corporations,” he says. “Corporate year-ends vary … you need to be mindful of fiscal year-ends for your corporate clients, and triggering losses well in advance of those deadlines.”
Looking across asset classes on a trailing 12-month basis, Burkett says fixed income has been the category most likely to contain losses. As central banks including the Federal Reserve and the Bank of Canada embarked on their aggressive rate-hiking campaigns to tame inflation, coupons on bonds have been rising, and prices have generally been falling over the past year.
“We construct bond portfolios for clients, and we’ll often buy and sell bonds opportunistically,” he explains. “If you buy a corporate bond maturing in 2026, sell it for a loss, and buy a bond from the same issuer with a different maturity date, you can trigger the loss immediately.”
Why bonds are better for tax-loss selling
The fact that bond prices have taken a beating could also present another benefit for clients. From a tax perspective, Burkett says returns from capital gains are the best type of investment income, as they may benefit from more favourable tax treatment like special credits or reduced inclusion rates.
The same isn’t true for interest income. Depending on their province or territory of residence, Canadians at the highest taxable income tax bracket will be taxed on their interest income at rates ranging from roughly 39% to 48%.
“We can potentially purchase a bond at a depressed price, and a portion of the investment income on that bond may arrive in the form of capital gains and not investment income,” Burkett says. “This is something we’ve been doing for clients since mid-2022 … thinking about how we can reposition holdings within the bond basket to maintain certain portfolio characteristics, while benefiting from tax losses.”
When executing a tax-loss strategy, investors should also be mindful not to trigger the superficial loss rule. Under the Canadian Tax Act, a taxpayer who sells a security at a loss can’t claim a deduction on it if they or someone affiliated with them – their spouse or a family member, for example – buys the same or a similar security within 30 days of the sale.
There’s another advantage to tax-loss selling in bonds rather than stocks. To maintain the overall portfolio’s risk and return characteristics, the security that’s sold at a loss must be replaced with another that has a similar risk-return profile. Stock investors usually do this by focusing on specific sectors – large banks, for example – but it’s not a perfect solution.
“Within equities, every stock is issued by a different company. Some companies will be driven by similar forces, but each one is its own business with different profit drivers,” Burkett says. “In bonds, one company might have dozens of bonds outstanding, so we can sell one bond and buy a different one from the same company, while not necessarily changing the performance of the portfolio.”
