{"id":422,"date":"2014-10-28T22:39:42","date_gmt":"2014-10-29T02:39:42","guid":{"rendered":"http:\/\/www.adjustedcostbase.ca\/blog\/?p=422"},"modified":"2022-04-29T20:36:04","modified_gmt":"2022-04-30T00:36:04","slug":"what-is-the-superficial-loss-rule","status":"publish","type":"post","link":"https:\/\/www.adjustedcostbase.ca\/blog\/what-is-the-superficial-loss-rule\/","title":{"rendered":"What Is the Superficial Loss Rule?"},"content":{"rendered":"

The superficial loss rule defines certain situations in which capital losses are disallowed.\u00a0 Section 54 of the Income Tax Act<\/a> indicates that a superficial loss is a loss occurring from the sale of property when both of the following two conditions are met:<\/p>\n

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    \n
  1. \n

    During the period that begins 30 days before and ends 30 days after the disposition, the taxpayer or a person affiliated with the taxpayer acquires a property (in this definition referred to as the \u201csubstituted property\u201d) that is, or is identical to, the particular property.<\/p>\n<\/li>\n<\/ol>\n

    AND<\/p>\n

      \n
    1. \n

      At the end of that period, the taxpayer or a person affiliated with the taxpayer owns or had a right to acquire the substituted property.<\/p>\n<\/li>\n<\/ol>\n<\/blockquote>\n

      Overview of the Superficial Loss Rule<\/strong><\/span><\/p>\n

      In cases where a superficial loss occurs, the capital loss cannot be claimed.\u00a0 Depending on the circumstances, the loss may be either permanently denied, denied but added to the adjusted cost base of any remaining or repurchased shares (with the effect of deferring the capital loss and reducing the capital gain when the remaining shares are eventually sold), or in some cases partially denied<\/a>.<\/p>\n

      The superficial loss rule applies to the period beginning 30 days before the settlement date of the sale transaction for the capital loss in question, until 30 days after the settlement date.\u00a0 This encompasses a 61-day period (the 30-day period before the settlement date of the sale, the settlement date itself, and the 30-day period after the settlement date).\u00a0 This time period is illustrated in the diagram below:<\/p>\n

      \"Superficial<\/a><\/p>\n

      As an example, suppose that a settlement date for a sale occurs on September 5th, 2014.\u00a0 The 61-day superficial loss period would be from August 6th, 2014 to October 5th, 2014 inclusive, as shown below:<\/p>\n

      \"Superficial<\/a><\/p>\n

      Note that this time period is defined in terms of calendar days\u00a0\u2014<\/span> not business days or stock market trading days.<\/p>\n

      If a sale transaction triggers a loss, the superficial loss rule will apply if the following conditions are met: you’ve bought the same or identical property during this 61-day period, and you still own or have the right to acquire the same or identical property at the end of the 61-day period.\u00a0 In such a case, all or part of the capital loss will be denied.<\/p>\n

      The superficial loss rule is in place in order to prevent taxpayers from partaking in artificial transactions for the purpose of triggering an immediate capital loss.\u00a0 Without the existence of the superficial loss rule, a taxpayer would be able to sell shares, trigger a capital loss, then immediately repurchase the same shares.\u00a0 In other words, a capital loss could be harvested without any meaningful change in ownership.\u00a0 Note that if this were allowed, the total capital loss (or gain) over the holding period would be the same regardless of whether or not the loss harvesting transaction takes place (as we’ll see with some examples below).\u00a0 However, triggering the capital loss immediately has the advantage of providing a tax advantage sooner rather than later.\u00a0 This is because the capital loss can be applied against any capital gains right away, as opposed to when the shares are sold in a more permanent fashion in the future.\u00a0 This can be viewed as advantageous due to the time value of money (a dollar today is worth more than a dollar tomorrow).\u00a0 The purpose of the superficial loss legislation is to remove the advantage that would result from these kinds of artificial transactions.<\/p>\n

      To be clear, transactions that fall under the conditions of the superficial loss rule are not illegal (for example, they’re not akin to insider trading).\u00a0 You’re perfectly within your rights to engage in transactions that follow under these conditions.\u00a0 However, you must make sure that you don’t claim a capital loss in a case where it’s disallowed by the superficial loss rule.<\/p>\n

      Example #1<\/strong><\/span><\/p>\n

      Let’s look at an example.\u00a0 Suppose that you purchase 100 shares of XYZ Inc. for $50 per share with a settlement date of January 6th, 2014.\u00a0 The ACB becomes $5,000 or $50 per share (assuming no transaction costs for simplicity).\u00a0 Then the share value declines to $30 per share.\u00a0 Let’s assume that you believe the shares are undervalued and that the share price will increase in the future so you want to maintain ownership of the shares.\u00a0 But with the decline in value, you see the opportunity to trigger a capital loss to reduce your tax bill for the current year.\u00a0 So, you sell all 100 shares on November 3rd, 2014 for $30 per share.\u00a0 You record a loss equal to $2,000 ((100 shares x $30\/share)\u00a0\u2014<\/span> $5,000).\u00a0 Then, because you’d like to maintain ownership, you repurchase 100 shares for $30 per share with a settlement date of November 4th, 2014 (since it’s only been a day, it’s likely that the share price hasn’t changed by much).\u00a0 Ignoring the superficial loss rule, your ACB becomes $3,000 or $30 per share.\u00a0 5 years later, the share price has risen to $80.\u00a0 You sell your 100 shares with a settlement date of December 2nd, 2015, and realize a capital gain of $5,000 ((100 shares x $80\/share) \u2014<\/span> $3,000).\u00a0 These transactions are summarized below:<\/p>\n

      Violation of the Superficial Loss Rule<\/span><\/p>\n

      \n\r\n\r\n
      <\/th>\nSettlement Date<\/th>\n Transaction<\/th>\n Shares Bought or Sold<\/th>\nPrice Per Share<\/th>\nShare Balance<\/th>\nACB<\/th>\nACB per Share<\/th>\nCapital Gain (Loss)<\/th>\n<\/tr>\n<\/thead>\n
      1.<\/td>\n2014-01-06<\/td>\nBuy<\/td>\n100<\/td>\n$50<\/td>\n100<\/td>\n$5,000<\/td>\n$50<\/td>\n\u2013<\/td>\n<\/tr>\n\r\n
      2.<\/td>\n2014-11-03<\/td>\nSell<\/td>\n100<\/td>\n$30<\/td>\n0<\/td>\n$0<\/td>\n$0<\/td>\n($2,000)<\/td>\n<\/tr>\n\r\n
      3.<\/td>\n2014-11-04<\/td>\nBuy<\/td>\n100<\/td>\n$30<\/td>\n100<\/td>\n$3,000<\/td>\n$30<\/td>\n\u2013<\/td>\n<\/tr>\n\r\n
      4.<\/td>\n2015-12-02<\/td>\nSell<\/td>\n100<\/td>\n$80<\/td>\n0<\/td>\n$0<\/td>\n$0<\/td>\n$5,000<\/td>\n<\/tr>\n<\/tbody><\/table><\/div>\n

      Note that the net capital gain over the holding period is $3,000 ($5,000\u00a0\u2014<\/span> $2,000).\u00a0 Claiming the capital loss for the November 3rd, 2014 transaction is not allowed according to the superficial loss rule.\u00a0 This is because a repurchase of shares happens within the 61-day period centred around the sale settlement date (specifically, the repurchase happens just 1 day after the sale).\u00a0 Also, the shares are still owned at the end of the 61-day period, satisfying the other half of the superficial loss rule.<\/p>\n

      In the table above, we have incorrectly assumed that the superficial loss rule does not apply and that the capital loss can be claimed.\u00a0 But according to the superficial loss rule, the loss should in fact be denied, and the amount should be added back to the ACB.\u00a0 So the transactions should be recorded as follows:<\/p>\n

      Applying the Superficial Loss Rule<\/span><\/p>\n

      \n\r\n\r\n
      <\/th>\nSettlement Date<\/th>\n Transaction<\/th>\n Shares Bought or Sold<\/th>\nPrice Per Share<\/th>\nShare Balance<\/th>\nACB<\/th>\nACB per Share<\/th>\nCapital Gain (Loss)<\/th>\n<\/tr>\n<\/thead>\n
      1.<\/td>\n2014-01-06<\/td>\nBuy<\/td>\n100<\/td>\n$50<\/td>\n100<\/td>\n$5,000<\/td>\n$50<\/td>\n\u2013<\/td>\n<\/tr>\n\r\n
      2.<\/td>\n2014-11-03<\/td>\nSell<\/td>\n100<\/td>\n$30<\/td>\n0<\/td>\n$0<\/td>\n$0<\/td>\n($2,000)<\/del> $0<\/td>\n<\/tr>\n\r\n
      3.<\/td>\n2014-11-04<\/td>\nBuy<\/td>\n100<\/td>\n$30<\/td>\n100<\/td>\n$3,000<\/del> $5,000<\/td>\n$30<\/del> $50<\/td>\n\u2013<\/td>\n<\/tr>\n\r\n
      4.<\/td>\n2015-12-02<\/td>\nSell<\/td>\n100<\/td>\n$80<\/td>\n0<\/td>\n$0<\/td>\n$0<\/td>\n$5,000<\/del> $3,000<\/td>\n<\/tr>\n<\/tbody><\/table><\/div>\n

      Applying the superficial loss rule results in a capital loss of $0 for November 3rd, 2014 and a capital gain of $3,000 on December 2nd, 2015.\u00a0 The denied capital loss of $2,000 is subsequently added to the ACB.\u00a0 The total net capital gain, $3,000, is the same as above when we ignore the superficial loss rule.\u00a0 Although the net capital gain is identical in both cases, the first interpretation of the transactions is likely to be more desirable from the taxpayer’s point of view due to the time value of money.\u00a0 But the CRA does not allow a capital loss to be claimed on November 3rd, 2014 because it’s deemed to be a superficial loss.<\/p>\n

      Example #2<\/strong><\/span><\/p>\n

      As you can see, the superficial loss rule disallows claiming a capital loss when you sell shares and then repurchase them shortly after (within 30 days following the settlement date of the sale).\u00a0 But what about the other way around?\u00a0 What if you own shares that have declined in value – can you purchase more shares and then sell them immediately after to trigger a capital loss?<\/p>\n

      Let’s look at a second example, similar to the one above but with a slightly different set of transactions:<\/p>\n