Editor’s note: This article was originally published in December 2010. It has been updated to be current as of April 2020.
Tax-loss selling discussions with clients tend to occur either at year-end or during a downturn in the markets. These are appropriate times to implement tax-loss selling strategies that will provide clients tax relief when they file their T1 personal tax return. The process of selling losing investments is fairly straightforward when clients have no further intention of owning them, so they cut their losses 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 be wary of how the superficial loss rules could impact tax-loss selling. Furthermore, advisors 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, 2019. On November 17, 2019, Kyle sold all 1000 trust units of XYZ mutual funds at $7.00 / unit. On November 21, 2019, Kyle reacquired 1000 trust units of XYZ mutual funds at $6.00 / unit. On December 17, 2019, 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 repurchase 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. The Canada Revenue Agency (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.
One option for Kyle is to consider repurchasing XYZ mutual fund in a corporate class version (assuming this option is available). A corporate class 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.
Another option may be to purchase an ETF that provides exposure to the same market, industry and/or companies that are similar to the those of the disposed investment.
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.
Oddly enough, however, parents, siblings and children/grandchildren are not considered to be ‘affiliated’ with you for tax purposes. Therefore, an opportunity exists for Kyle to transfer investments in a capital loss position “in-kind” to a son or daughter, for example, without worrying about the superficial loss rules affecting his ability to claim the capital loss when he files his tax return.
Since a spouse/CLP is considered to be an affiliated person, the superficial loss rules will apply if any investments sold at a loss in the previous 30 days are repurchased by the spouse/CLP. In some situations, it would be desirable if clients could transfer their unrealized capital losses to the spouse/CLP. Examples include situations where spouses are in very different tax brackets and it would be desirable for the higher income earner to benefit from the capital losses, or, the spouse with the capital losses has no capital gains to offset the losses against while his or her spouse/CLP does.
Fortunately, there is a strategy that allows clients to transfer unrealized capital losses to a spouse or CLP while taking advantage of the superficial loss rule. In Kyle’s example from above, he sold all 1,000 mutual fund units on November 17, 2019 and triggered a $3,000 capital loss.
If his wife Anita, repurchased the same mutual funds on November 21st, 2019 for $6/unit, the superficial loss rules would apply to deny Kyle his capital loss. If the desire is to transfer capital losses to Anita, then Kyle needs to have the superficial loss rule apply to deny his capital loss. The reason is that, Kyle’s denied capital loss; $3,000 in this case, would be added to the adjusted cost base of Anita’s newly purchased investments, so her cost base will rise from $6,000 to $9,000. Once 30 days have passed from the time Kyle sold his investments, Anita can sell the investments and trigger the capital loss (assuming the investments have not gone up in value since the repurchase). This capital loss will now belong to Anita instead of Kyle.
It is also important to note that clients are affiliated with any registered plans for which they are the majority interest beneficiary, including RRSPs, RRIFs, TFSAs and RESPs. That is, the superficial loss rules will apply to deny your client any capital loss triggered if the investments are sold and repurchased within their RRSP, RRIF, TFSA or RESP within 30 days.
With respect to RESPs, the CRA’s general position is that your client will be affiliated to any RESP on which they are the subscriber. The position is based on the rights a subscriber typically has under the RESP, including the right to receive a refund of payments and a contingent right to receive an accumulated income payment (AIP). Therefore, if clients are looking to trigger capital losses and repurchase those investments within their RRSP, TFSA or RESP, they should sell the investments to cash, contribute the cash proceeds to the registered plan and wait until 30 days have passed from the time of the disposition before repurchasing the identical property, in order to sidestep the superficial loss rules.
Tax-loss selling is a value-added approach many advisors implement for their clients. Understanding the superficial loss rules and how to sidestep them can go a long way to helping your clients minimize their income tax bills.