skip to Main Content

How to Avoid Falling into the Superficial Loss Trap?

Key Points:

  1. The purpose of the superficial loss rules is to prevent taxpayers from immediately repurchasing the same or identical property (called “substituted property”) after selling it to obtain tax advantages.
  2. Conditions triggering the superficial loss rules include purchasing the substituted property within a specific timeframe before and after the sale.
  3. The simplest way to avoid triggering superficial losses is to wait for at least 31 days before repurchasing the substituted property.

Many savvy investors often review their financial situations before the end of the year. This is not only to understand how much they’ve earned in the year but also to look for potential strategies to improve their tax situation. One popular strategy is to sell losing investments and use the resulting capital losses to offset capital gains from other investments, reducing the tax liability for the year.

This may sound straightforward, but in practice, it’s not as easy as it seems. This is because it goes against one’s intuition, as you need to sell investments that are in a loss position. Additionally, there’s a regulation called the “Superficial Loss” rule that complicates matters further. In this article, we will delve into the Superficial Loss rule in detail to help you steer clear of potential pitfalls.

What is a Superficial Loss?

The superficial loss rule is a provision in Canadian tax law designed to prevent taxpayers from selling a capital property and immediately repurchasing the same or identical property (called “substituted property”) solely for the purpose of obtaining a tax advantage. The individuals repurchasing the property include not only yourself but also those affiliated with you.

For instance, if you own a currently losing stock that you believe will recover in the long term, you cannot sell it simply to offset a capital loss and then repurchase it immediately. Such a transaction would be considered a superficial loss and cannot be used to offset taxes. In the eyes of the Canadian government, you are conducting the transaction for tax avoidance, not a genuine sale of a losing asset.

When Does the Superficial Loss Rule Trigger?

To trigger the superficial loss rule, your selling transaction must meet both of the following conditions:

  1. Within 30 days before the sale and 30 days after the sale (a total of 61 days), you or someone affiliated with you purchases or has the right to purchase the substituted property.
  2. 30 days after the sale, you or someone affiliated with you still owns or has the right to purchase the substituted property.

What Are Considered Identical Properties (Substituted Properties)?

“Identical properties” refer to properties with no significant differences in all essential aspects to the extent that a prospective purchaser would not have a preference for one property over the other. Evaluating whether properties are the same or similar entails comparing the inherent characteristics or elements that distinguish each property.

In other words, triggering a superficial loss doesn’t require that the property repurchased be the same as the original property. If these properties are sufficiently similar in essence, they may be categorized as identical. For example, if you sell an ETF tracking the Canadian TSX 60 index (e.g., XIU) and subsequently acquire another ETF tracking the same index (e.g., HXT), this transaction could trigger a superficial loss, as these properties are similar enough.

Who Is Considered an Affiliated Person?

Affiliated persons include your spouse, common-law partner, companies controlled by you, majority interest partners in a partnership, trusts and beneficiaries holding a majority interest, and persons related to these beneficiaries, among others. This also includes your registered accounts such as RRSP, RRIF, TFSA, and RESP.

How to Avoid Triggering the Superficial Loss?

The simplest method to avoid triggering the superficial loss is to wait for at least 31 days after selling a property before repurchasing the same or identical properties.

What to Do If You Trigger the Superficial Loss Rule?

If you trigger the superficial loss rule, you won’t be able to immediately use the capital loss to offset capital gains. Instead, you should add the capital loss (superficial loss) to the adjusted cost base of the repurchased properties and use it in future capital gains tax calculations. Given the complexity of the calculation, when you find yourself in this situation, we recommend consulting a professional tax advisor to ensure you handle this rule correctly and minimize your tax burden.

Tip: Transaction Date vs. Settlement Date

When considering selling losing investments at year-end or calculating the superficial loss date, you should use the settlement date, not the transaction date. Currently, in Canada, the settlement date for stocks and ETFs is two business days after the transaction date (commonly referred to as T+2). For example, for the year 2023, if you want to use your stock and ETF capital losses in the same year, your transaction date must be no later than December 27, 2023, to ensure settlement is completed before the year-end (due to December 30 and 31 falling on the weekend).

The superficial loss rule is an important provision in Canadian tax law aimed at preventing the abuse of the tax system for undue advantages. While this rule may seem complex, its purpose is to ensure fairness and equity in the tax system. For investors, understanding and complying with the superficial loss rule can help them optimize their financial strategies and avoid unnecessary tax issues. Before engaging in any investment transactions, it is advisable to consult a tax professional to ensure compliance and develop the best tax strategy.

For detailed information about the Superficial Loss rule, please visit the official website of the Canadian government: “What is a superficial loss?

Published Date: November 6, 2023

All content in this article and on the “website” is for general information purposes and does not constitute any specific advice for individuals or entities, including legal, tax, investment, financial, or insurance advice. Please review the detailed disclaimer and copyright statement

Back To Top