Jamie Golombek: Tax-loss selling? Beware the ‘superficial loss’ rules

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Many financial markets are sharply down in 2022, so there’s been a lot of talk in the past month about tax-loss selling, a topic that generally only comes up at year-end. Tax-loss selling is the act of selling a security, say a stock, bond or mutual fund, that’s in a loss position in order to use that loss to recover tax paid or payable on capital gains.

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For this strategy to be effective, you must have capital gains, since capital losses can only be used to offset capital gains. You must first net any capital losses realized in 2022 against 2022 capital gains. Only if you have excess losses, can they then be carried back three years to recover taxes paid in 2021, 2020 or 2019, or be carried forward indefinitely to offset a capital gain in some future year.

In the context of depressed markets and tax-loss selling, however, a common sentiment among investors is that the markets will, eventually, rebound, and selling a stock at a loss, merely for tax purposes, could mean missing out on the price recovery if things turn around. To this end, wouldn’t it be nice to have your cake and eat it, too? In other words, sell your losing tech stock, realize the loss and then buy it back again to catch the recovery?

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The problem with doing so, as regular readers will know, is that you could get caught by the “superficial loss” rules if you buy back too soon. The superficial loss rules apply if property (or an “identical property”) that is sold at a loss is repurchased within 30 days, and is still held on the 30th day by you or an “affiliated person.” An affiliated person includes your spouse or partner, a corporation controlled by you or your spouse or partner, or a trust of which you or your spouse or partner is a majority-interest beneficiary (such as your registered retirement savings plan or tax-free savings account).

Under the rules, your capital loss will be denied and added to the adjusted cost base (tax cost) of the repurchased security. That means any benefit of the capital loss can only be obtained when the repurchased security is ultimately sold.

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Occasionally, the superficial loss rule can trip up unaware taxpayers in unexpected ways. Some planning scenarios were presented to the Canada Revenue Agency last fall at the Association for Tax and Financial Planning conference, and the CRA in June published its formal response in a technical interpretation.

The first scenario involved spouses who had separate brokerage accounts, each with different investment advisers at different financial institutions. On Sept. 1, 2021, Mr. A decided to sell 1,000 shares of ABC Corp. in his non-registered account. He incurred a capital loss of $20,000, because he had paid $30 per share back in 2018, and sold them for $10 per share.

On Sept. 7, 2021, his spouse, Ms. B, who has her account with a different adviser at a different brokerage firm, purchased, in her RRSP, 1,200 shares of ABC Corp. While having dinner on Sept. 20, the couple discussed their respective portfolios and soon realized that, coincidentally, Ms. B had acquired the same shares that Mr. A had sold at the beginning of September. The next day, while speaking with his adviser, Mr. A learns that his capital loss of $20,000 will be denied as a superficial loss.

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To avoid the loss being denied, Mr. A’s adviser suggests his wife dispose of her shares of the company no later than Sept. 28, 2021 (due to the two-business-day deadline following the day of the transaction for the trade to settle on the exchange). Thus, neither Mr. A nor an affiliated person (in this case, Ms. B’s RRSP) would own the property at the end of the 30-day period.

The CRA agreed that Mr. A’s loss is not a “superficial loss” in that case, because even though Ms. B’s RRSP is affiliated with Mr. A and it acquired the identical shares, it didn’t own them at the end of the 30-day period. Thus, Mr. A could claim the loss.

But what if Ms. B’s adviser insists that ABC Corp. shares are a good, long-term investment for her RRSP, despite her spouse’s decision to sell the same shares at the beginning of September 2021? The adviser suggests that on Oct. 1, 2021, she repurchase the 1,200 shares in her RRSP that she just sold on Sept. 28.

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The CRA commented that if she did, Mr. A’s loss would, indeed, be superficial since Ms. B reacquired the shares on Oct. 1, 2021, so her RRSP owned the shares in the period ending 30 days after Mr. A sold his shares (on Sept. 1, 2021). That’s because the calculation of the 30-period begins with the day after the disposition, making Oct. 1, 2021, the last day of the 30-day period.

But if Ms. B waits one extra day, until Oct. 2, to repurchase the shares in her RRSP, the CRA confirmed that the superficial loss rule would not apply. The agency did caution, however, that the Income Tax Act contains a general anti-avoidance rule, but refused to comment on its potential application in this situation.

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One final caveat about the superficial loss rules in the context of identical properties and index funds or exchange-traded funds. In 2001, the CRA stated that, in its view, index funds from different financial institutions are considered to be identical properties if they track the same index (say, the S&P/TSX composite), so simply selling one index fund and replacing it with a similar one from another issuer could trigger the superficial loss rules if it hasn’t been at least 30 days.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com

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