Know the rules before balancing share gains and losses ahead of financial year-end.

Tax-loss selling (also known as tax-loss harvesting) is a strategy some investors use to minimise their net capital gains during the financial year with a view to reducing their Capital Gains Tax (CGT) liabilities.

Although investors can choose to sell shares at a loss at any time, it is most often done by retail investors in the lead up to the financial year-end (June 30) - and is something Sharesight expects to see more of in response to COVID-19 sharemarket volatility.

In the broadest sense, tax-loss selling involves selling loss-making investments to realise capital losses, to “net out” capital gains the investor has realised during the year.

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article.)

Hypothetical example

Assume you bought CSL in 2012 when it traded at $32. CSL is at $305.84 (for this example), so on paper you have an annualised return of 33 per cent.

However, Retail Food Group (RFG), which you bought at $4 in 2014, is trading around $0.075 after some turbulent years.

Example: Sharesight

If you want to take some profits, you could sell some (or all) of your CSL shares and exit your loss-making position in RFG. This would offset some of the gains made in CSL — and perhaps soften the psychological blow of realising the loss in RFG.

Notes on tax-loss selling

• In the above example, since CSL has been held for longer than 12 months, it may be eligible for the CGT discount.
• Although many investors leverage tax-loss selling towards the end of the financial year, investors can harvest tax losses at any time within it.
• Capital losses on shares can in some circumstances be carried forward to offset future capital gains.
• Modelling tax-loss selling opportunities across larger portfolios is best done using a spreadsheet or specific software like Sharesight’s Unrealised Capital Gains Tax Report.
• Whether you are considered to be holding shares as an investor or a share trader matters to the Australian Tax Office (ATO), as gains for share traders are treated differently.

Avoid “wash” sales

When considering tax-loss selling, investors must be mindful of tax ruling TR 2008/1. It specifically forbids arrangements where “…in substance there is no significant change in the taxpayer’s economic exposure to, or interest in, the asset, or where that exposure or interest may be reinstated by the taxpayer”.

In other words, the ATO does not view kindly investors who sell a stock in one financial year to take advantage of a capital-loss event, only to buy that stock again in the new financial year. This is known as a “wash sale” and the ATO will disallow the loss if the sole intention of the sale was to minimise tax.

(Editor’s note: Investors should consult their financial adviser or accountant to understand how these rules apply to their circumstances.)

Why tax loss-selling often occurs in June

For tax purposes, each financial year is used as a snapshot in time to assess the tax payable by individual Australians. Because of this, the timing of when investment income is earned, or when investors realise capital gains/losses, is important.

Often this will mean that as investors near the end of the financial year, they look back over their portfolio and assess whether to bring forward the sale of particular investments to realise a capital gain or loss in the current financial year (to offset existing losses or gains), or to hold off a trade to fall in a subsequent financial year.

In fact, some experts believe many stocks that have fallen during the financial year could fall further in June as investors “tidy up” their portfolios and execute tax-loss selling. 

Further to this point, Sharesight always sees a jump in the number of investors using our Unrealised Capital Gains Tax Report through June as they seek to “lock in” their final portfolio position in the lead up to the June 30 financial year end.

Why tax-loss selling could be more pronounced this financial year

One word: volatility.

While ASX returns for the first half of the financial year have been some of the strongest since the 2008-09 Global Financial Crisis, the S&P/ASX 200 index is down around 8 per cent for 2020 (on a total return, year-to-date basis at June 10). Some sectors have fallen more than that.

This volatility has impacted the number of trades that Sharesight’s Australian users are conducting. The average number of trades for users on paid Sharesight plans is up more than 60 per cent in March compared to the same period in 2019.

With some investors ramping up their trading activity as they navigate the volatility of markets during the COVID-19 pandemic, we expect this to have implications for how many investors turn to tax-loss selling strategies as they attempt to net-out the gains (or losses) realised through this flurry of trading activity.

To understand how widespread this would be in the lead-up to the end of the financial year, Sharesight asked its users during May if they intended to sell loss-making investments in their portfolios before June 30, to offset gains made during the year. We found almost half of respondents (44 per cent) planned to do so.

The chart below shows the response:

Although much could change before the financial year-end, these responses say a lot about investors' willingness to crystallise losses to offset gains and place themselves in the best tax position to ensure a fresh start for the next financial year.

Conclusion

The sharemarket volatility caused by COVID-19 has seen many retail investors adopt a more active approach to investing. This includes an increase in trading activity and examining strategies such as tax-loss selling.

If you are considering this approach, it is important to be mindful of how this trading activity will affect your capital gains tax liabilities come June 30 – and understand ATO requirements.

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