Offsetting capital losses: weighing up the benefits

According to the experts, offsetting capital losses against capital gains is an intelligent strategy.

Michael Hutton, partner with HLB Mann Judd says: “Recouping losses from a personal wealth position and then not having to pay tax on a subsequent gain is a very common practice.”

But there is good news and bad news.

The bad news is that under the Income Tax Assessment Act, in order to offset a capital loss against a capital gain, both the loss and the gain must be realised.

“You cannot leave money in an investment which is making a loss and use it against a gain. You have to take it out and realise the loss,” Barbie Chiro from tax firm BKR Walker Wayland says.

While most clients are happy to sell investments in order to take a gain, they are usually less happy to sell assets when they are going to make a loss. What client wants to sell when the market is down, especially if they have not made a capital gain elsewhere?

RetireInvesttechnical manager Jennifer Brookhouse says that when deciding to sell underperforming assets, clients should always take the quality of the stock and future expectations into account.

Now for some good news.

Firstly, according to Hutton, clients are not restricted in the type of assets that can be used in the offsetting process — gains made from investing in property, for example, can be offset by losses on shares and vice versa.

The second piece of good news, according to Brookhouse, is that if a client does have to take a loss and has not made a capital gain in the same financial year, that loss can be carried forward indefinitely to offset future capital gains.

However, she warns that as the value of any carried forward loss is not indexed, the real value diminishes over time, so losses should be offset as soon as possible.

Hutton says to avoid diminishing the real value of a loss by carrying it forward, clients could consider a strategy involving selling some assets, for example, shares, at a profit, thereby realising a capital gain that can be offset against an accrued loss, then repurchasing the shares immediately. Both the capital gain and the capital loss are realised and the gain can be easily offset against the loss in the same financial year.

But Hutton also points out that there is a flaw in the whole offsetting strategy.

He says that if an asset has been held for more than 12 months, the 50 per cent discount rule applies to the capital gain — that is, tax is only payable on 50 per cent of the capital gain. But, where a client has to take a loss, that loss must be offset against 100 per cent of the capital gain. The client does not benefit from the 50 per cent discount.

Furthermore, Chiro says the 50 per cent discount is attractive, so it could be a bad move to sell an investment and realise a capital loss, when at some point in the future, the investment could make a gain.

“It may make more economic sense to just pay the tax,” she says.

What of losses made in managed funds and superannuation accounts?

Chiro says if an individual owns a managed fund, a loss within that investment can be offset against a gain elsewhere, but again, only if the loss is realised.

She says that if a client, for example, invests $20,000 in a fund and looks up the value in the paper to discover it is now worth just $15,000, that loss can be offset against a capital gain made on, say, an investment property — but only if the client sells out of the managed fund.

Super funds, Hutton reminds us, are not individual investments but separate taxable entities. Losses made in a super fund cannot be offset against gains made personally.

However, Chiro points out that losses and gains may be made in the same fund, so in effect, they may offset each other. Hutton says super funds can regather losses with gains made in future years.

Trustees of self-managed super funds have more control over the offsetting process. They could, Hutton says, see an asset that has performed well, and buy into that for the fund.

“This would neutralise any loss made within the super structure,” he says.