What is a Superficial Loss?

Investors may wish to harvest capital losses by selling shares and then re-purchasing those shares immediately with a lower cost base. Doing so would result in a tax benefit because investors could use the resulting capital losses to offset capital gains from other parts of their portfolio. But, CRA has closed this loophole by the “superficial loss” rules. To avoid the superficial loss rules, investors must wait at least 30 days after selling a security before purchasing it again.

Definition

CRA says that a superficial loss occurs when you dispose of capital property for a loss and both of the following conditions are met:

1. You, or a person affiliated with you, buys, or has a right to buy, the same or identical property (called “substituted property”) during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale.
2. You, or a person affiliated with you, still owns, or has a right to buy, the substituted property 30 calendar days after the sale.

Affiliated persons include:

• you and your spouse or common-law partner
• you and a corporation that is controlled by you or your spouse or common-law partner
• a partnership and a majority-interest partner of the partnership that you control

If you have a superficial loss, you cannot deduct the associated capital loss when you calculate your income for the year.

Examples

Here are some examples where investors might be caught by superficial loss rules:

• An investor contributes a stock with an unrealized loss to a registered account, thereby triggering a capital loss. However, this is a superficial loss and the realized capital loss is disallowed for tax purposes because the beneficial ownership has not changed.
• An investor rolls depreciated securities to a holding company they own & control. The capital loss cannot be realized for tax purposes because the beneficial ownership has not changed.
• An investor transfers a depreciated stock to their spouse’s account. The capital loss cannot be realized because the spouses is “affiliated”.

Strategies for Avoiding Superficial Loss Rules

Investors may be transferring assets, selling assets, or changing the ownership of assets for various reasons outside of realizing capital losses. But, when doing so, many investors still want to be able to use the resulting losses from disposition. Below are some strategies that may help investors avoid superficial loss rules.

Fund & ETFs

ETFs are useful for tax planning. Since multiple ETF issuers list ETFs on similar indexes (multiple ETF issuers list ETFs on the S&P 500 for an example), investors can use ETFs to harvest tax losses by selling the shares in an ETF with unrealized gains and purchasing another ETF based on the same or similar indexes as a substitute. Doing so avoids the superficial loss rules since the securities are not identical.

If you’re considering selling an ETF to harvest tax losses but cannot find an alternative ETF tracking an identical index, you might find that even though the indexes underlying multiple ETFs might not be identical, many broad market indexes contain similar stocks. Consider looking for ESG index ETFs, they may contain many of the same underlying securities and may perform almost identical to their non-ESG counterparts. Also, consider indexes from different index providers that track similar groups of stocks. Like, index ETFs that use indexes from Dow Jones, S&P, MSCI, etc.

Options Strategies

Another way to avoid superficial loss rules while still maintaining exposure to an underlying asset is to use options. Options strategies can be built to “synthesize” the return of an underlying stock without owning it. And, options can be used to change the exposure to an underlying stock based on an investor’s expectations.

For example, an investor could sell an “at the money” put and purchase an “ at the money call of a stock they just sold to avoid superficial loss rules. Depending on the price of the underlying stock relative to the strike prices of the options, and the put/call parity at the time of the transaction; the trade could be arranged as a “no cost” spread.

Bottom Line

To harvest losses for tax purposes, CRA has made the rules to that investors need to take some market risk or other risk. Investors could use option strategies to synthesize the position that was sold. Investors can use mutual funds & ETFs of similar asset classes to earn similar returns. Or investors can harvest tax losses and simply wait at least 30 days before re-purchasing identical securities. The best professional you should consult with regarding superficial loss rules is your investment advisor.