How will tax loss selling affect cannabis investors?

QUESTION: “Some people are talking about tax loss selling happening at this time of year. Should I be concerned? Is there more I should be aware of? Can you explain a little about how this works, please?”

From D.N. in Vancouver, Canada

ANSWER: Your question is very timely for Canadian and American cannabis investors and perhaps others. It seems I am always explaining what I am not but I am not an income tax expert and I am not giving income tax advice. What follows is a general description of how Canadian tax regulations might impact Canadian investors and the cannabis stock market. It is not intended to be tax advice. Please consult a qualified income tax expert before implementing personal tax strategies.

If ever there ever was a year for tax loss selling to impact markets it is this year. These are the charts for the LTB Marijuana Composite and the LTB Licensed Producer Index in the 2018 taxation year. The charts show that 2018 started with relatively high cannabis stock prices and there were ample opportunities for investors to have sold cannabis stocks and realized a profit. Because the trend in prices this year has been generally down, it also means those investors may have unrealized losses in their portfolios. Anyone with net realized gains will probably face paying taxes on capital gains. But if they realize an appropriate level of losses, they may be able to offset their gains and avoid a tax bill. Not only that you can apply capital losses to offset capital gains for the previous three years even if you have already filed your returns for those years, reported the capital gains and paid the tax. Realized losses can be carried back three years and carried forward indefinitely.

The tax loss sale can be a very powerful tool in tax planning. This implies that there may be pent up tax loss motivated selling of cannabis stocks that will be acted on between now and just after Christmas. This suggests increased selling pressure for the time being.

If you are considering tax loss selling, there are a couple of pitfalls to avoid. First, your sale must settle in 2018. The trade date doesn’t matter but the trade must settle in 2018. This means with common stocks, you must complete the selling transaction no later than December 27, 2018. If you’re selling options, the date is December 28, 2018.

If you sell a stock, neither you, nor your spouse nor a company controlled by your spouse, can buy back the same stock or a “substantially identical” stock within 30 days. If you do it will be considered a “superficial loss” or, in stock market parlance, a wash trade and the loss will not be allowed. For example selling Aphria to crystallize a loss and immediately buying back Aurora would not create a superficial loss. But if you sold Canopy and bought back call options to buy Canopy common shares, this would be considered a wash trade.

Interestingly enough, your children can buy back the shares. There may be instances when this is a worthwhile plan but you must consult with a professional tax advisor before undertaking such a transaction.

If you and your professional tax advisor decide to engage in some tax loss harvesting, do it early. Also it is worth remembering that stocks trading or close to their 2018 lows are the ones most likely to be tax loss sold. So the depressed stocks get a double whammy. Not only are they already down, tax loss sellers pile on and sell some more. This also means these stocks are often the ones that rebound the most. So if you tax loss harvest now, you can restore positions early in the new year and avoid the superficial loss rule. Remember the thirty days begins right after settlement day – not trade day.

In conclusion, tax loss selling pressure can push a group of stocks, such as the cannabis stocks, lower. So if you see weakness as we approach and pass Christmas you might have a buying opportunity. Focus on buying stocks that are trading substantially below half way down from its 2018 high.