Tax Loss Selling
Thinking of Tax Loss Selling? Beware of superficial losses.
Tax loss selling is the term used for the sale of an investment at a loss in order to specifically reduce the taxable capital gains on other investments.
Who can this apply to?
Investors who have realized significant capital gains during the current and any of the previous three taxation years may have benefits from tax loss selling. Capital losses realized in the current year are automatically applied towards capital gains of the same year. You may also carry back these losses up to three years to recover the taxes paid on previously reported capital gain, and any unused capital losses can be carried forward indefinitely. There are certain provisions of Canada’s Income Tax Act that can prevent certain losses from being used to offset capital gains. These are called superficial or suspended loss.
What is a superficial loss?
A “superficial loss” is defined as a loss from a sale of an investment where:
- During the period within 30 days before or 30 days after the settlement date of the sale of an investment, the investor or an affiliated person to the investor purchases an investment that is an identical investment, to the investment sold; and
- At the end of that period, the investor or an affiliated person holds/owns the investment or identical investment.
Both TFSAs and RRSPs can hold a range of investment products, including:
- Cash, guaranteed income certificates (GICs) and other deposits.
- Shares, warrants, options, exchange-traded funds (ETFs) and real estate investment trusts (REITs).
- Mutual funds and segregated funds.
- Canada Savings Bonds, provincial savings bonds and regular bonds.
- Insured mortgages.
Consequence of a superficial loss
Where a superficial loss is identified, the loss is deemed nil and is deferred by adding the loss to the adjusted cost base (ACB) of the investment purchased by the investor or the person affiliated with the investor. When the investment is ultimately sold, the capital loss is realized by the individual or the person affiliated with the individual.
Situational example: In order to trigger capital losses, Mr. Smith would like to dispose of all 500 shares of investment “A” in his open, non-registered account. His wife, Mrs. Smith, purchased 50 shares of the same investment in her open, non-registered account 27 days ago. If Mr. Smith were to sell these shares today, one tenth (50/500) of his capital loss would be superficial, deemed nil and deferred for tax purposes. As well, the deferred loss portion would be added to the ACB of Mrs. Smith’s 50 shares of Investment “A”.
Proposed solution: As Mrs. Smith purchased her shares of Investment A 27 days ago, a suggestion would be for Mr. Smith to wait an additional four days to dispose of his Investment “A” shares and for him and his wife to not acquire further units for 30 days following the settlement day of his disposition.
What is an affiliated person?
- The term “affiliated person” is more specific than the term related party. In brief, an affiliated person may be an individual, trust, partnership or corporation. An individual is affiliated with themselves and with a spouse or common-law partner, but NOT with a child, parent or sibling.
- An individual is affiliated with a trust where he or she is a majority interest beneficiary of the trust, or is affiliated with a major interest beneficiary, such as a spouse or common-law partner.
- An individual is affiliated with a corporation by virtue of control (control is greater than 50%). Where control over a corporation is held by an individual (and his or her spouse or common-law partner) is affiliated with the corporation.
What are identical investments?
“Identical investments” are capital assets that are the same in all material respects, namely interests, rights, underlying assets, benefits and privileges. A potential buyer would have no precedent as to which asset to acquire.
Situational example: Mr. Black purchased 10 shares of Investment “B”. The collective 10 shares are identical properties as there is no distinction between the first share and the ninth share in terms of rights, underlying assets, benefits, etc.
Instead, if he had purchased five shares of Investment “B” and five shares of Investment “C” the shares of investment “B” or Investment “C” would not be identical properties as the rights, underlying assets, and benefits between the two positions are different.
Situational example: Mr. Brown purchased 10 shares of an ETF that passively tracks the ABC index from fund provider “X”. He then sells this fund at a loss.
Later he purchases 10 shares of an ETF that tracks the same “ABC” index from fund provider “Y.” Mr. Brown believes that because he purchased the new ETFs from different providers, his investments are not considered identical but, this is not the case.
The ETFs purchased from two different fund providers are still considered identical properties because they track the same index. However, if Mr. Brown were to purchase 10 shares of an ETF that tracks the “ABC” index from fund provider “X” and then later purchase 10 shares of an ETF that tracks the “HIJ” index from fund provider “Y,” these would not be considered identical properties because the ETFs track a different index.
The same is true for mutual funds. As long as the fund tracks a different index or even a variant of the original index, they are not considered identical properties.
Can your spouse benefit from your loss?
If you have an unrealized capital loss but no capital gains against which to apply those capital losses, you might be able to transfer the unrealized capital loss to your spouse. You would trigger a capital loss by selling an investment that has dropped in value, and your spouse would then acquire the identical investment on the open market – within 30 days of your sale. This would cause your capital loss to be deferred because of the superficial loss rules. The deferred loss would be added to the ACB (after the 30th day from the date of your sale) and realize a capital loss that your spouse may be able to use. This is an effective tax-planning tool where one spouse has reported capital gains and the other has not.