At this time of the year, you may be helping your clients implement tax loss selling strategies that will provide clients tax relief when they file their tax return in April. The process of selling losing investments is fairly straightforward when clients have no further intention of owning them, so they might as well cut their losses before year end to reap the tax benefits as soon as possible.
However, it may be more difficult trying to harvest losses on investments which clients would like to continue to own. In these cases, advisors should understand how the superficial loss rules could impact tax loss selling. Furthermore, you may consider ways to sidestep the superficial loss rules so clients can reap the benefits from tax loss selling.
The Income Tax Act defines a superficial loss to be a loss from the sale of a particular property where the same or identical property is acquired by the individual, or an affiliated person, during the period beginning 30 calendar days before the sale and ending 30 calendar days after the sale. At the end of that period, the individual or the affiliated person must continue to own the same property. The amount of any capital loss that is deemed to be a superficial loss is added to the adjusted cost base (ACB) of the substituted property.
Here’s an example. Kyle bought 1000 XYZ mutual fund trust units with a NAV of $10.00 / unit on November 3, 2010. On November 17, 2010, Kyle sold all 1000 trust units of XYZ mutual funds at $7.00 / unit. On November 21, 2010, Kyle reacquired 1000 trust units of XYZ mutual funds at $6.00 / unit. On December 17, 2010, Kyle still owned all 1000 units of XYZ mutual fund.
Since Kyle acquired the identical property within 30 days of the sale of his 1000 units of XYZ mutual fund and he still owned the investments 30 days after the sale, Kyle has a superficial loss of $3,000 ($7,000 – $10,000). The $3,000 capital loss is then added to the ACB of the newly acquired units.
In order to ensure that the superficial loss rules will not apply to your clients who want to take advantage of their capital losses for tax purposes, clients simply need to wait 30 days from the time the investments are sold before repurchasing the same investment.
However, is this always the case? Can your clients get back into the investments sooner without having the superficial loss rules apply? To do this effectively, advisors and investors need to understand how and when the superficial loss rules apply.
First, the superficial loss rules apply when an investment is sold and the ‘same or identical’ property is repurchased within 30 days. CRA has stated in the past that an identical property is one in which the properties are the same in all material respects, and that a prospective buyer would not have a preference for one investment over the other.
In Kyle’s situation, it is pretty clear that since he sold XYZ mutual funds and repurchased XYZ mutual funds within 30 days that he in fact repurchased an ‘identical’ property. Therefore, his capital loss will be denied. However, Kyle could consider repurchasing a “similar” investment within the 30 day window, one that is not the same in all material respects, and therefore not have the superficial loss rules apply.
For example, Kyle could consider repurchasing XYZ mutual fund in a corporate class version (assuming this option is available for Kyle). A corporate mutual fund is fundamentally very different from a mutual fund structured as a trust, and hence, they would not be considered identical properties. Therefore, by repurchasing the corporate class version of XYZ mutual fund, Kyle is able to maintain exposure to the same type of investment, yet avoid the superficial loss rules and claim the loss for tax purposes.
The superficial loss rules will apply when you or someone ‘affiliated’ with you repurchases the same or identical property. So, who is considered affiliated with you? Well, a spouse or common-law partner (CLP) is considered affiliated with you. In addition, a corporation controlled by you or your spouse/CLP, certain partnerships, and trusts in which you or a person affiliated with you is a majority-interest beneficiary are also considered affiliated with you.