A superficial loss is a capital loss that the Canada Revenue Agency (CRA) does not allow you to claim because the loss did not occur from an independent arm’s length transaction and can be deemed as a way to avoid taxes on your capital gains.
A superficial loss is a loss that occurs on capital property disposition when you or someone affiliated with you buys or has the right to buy the property or an identical property (also referred to as the substituted property) within a period that begins at thirty calendar days before the sale of the property and ends at thirty calendar days after the property sale.
Superficial Loss Rules
The primary rules that guide superficial loss recognition involve the following:
Relationship Between Parties
If a capital disposition involves affiliated parties, any loss from the transaction can be deemed a superficial loss.
Affiliated parties include you, your spouse or common-law partner, a corporation that you or your spouse or common-law partner controls, a partnership that you or your spouse or common-law partner have, a trust that your or your spouse or common-law partner are beneficiaries with majority interests.
Determining if a property purchase is an identical property will depend on the type of property and circumstance.
Generally, you need to consider the specific elements and qualities of the capital properties involved to determine if they are identical properties.
For example, the shares of a company can be assessed as identical properties if they have the same interests, rights, and privileges, and not necessarily by the price or value of the shares.
Period of Transaction and Settlement
A major rule for determining superficial losses is the period from when you sell the capital property and when you or an affiliated person purchases or has the right to purchase the property or identical property.
There is a 61-day window that determines if your capital property sale loss is superficial.
This window is between 30 days before you sold the capital property and 30 days after you sold the capital property.
If you or an affiliated person buys or has the right to buy the sold property (or an identical property) within the 61-day period, you can trigger a superficial loss.
A superficial loss also depends on if you or an affiliated person still owns or has the right to buy the capital property 30 days after you have sold it.
Defining Capital Property
To understand how a superficial loss works, you need to know what the CRA considers capital property, capital gains, and losses.
Capital property is any property that you can dispose of and incur capital gains or losses.
Capital property includes stocks, bonds, exchange-traded funds, mutual funds, land and buildings and equipment.
Generally, you purchase a capital property for investment purposes.
Defining Capital Gain and Capital Loss
When you dispose of capital property, the proceeds from the capital property disposition will be compared to the property’s adjusted cost base to determine if you have a capital gain or loss.
You have a capital gain if the proceeds from the disposition are more than the adjusted cost base which is the purchase price plus other expenses incurred to buy and sell the property.
On the other hand, if the proceeds from the capital property disposition are lower than the property’s adjusted cost base, you have a capital loss.
Only half of your capital gains are subject to tax for capital gains tax purposes.
Likewise, only half of your capital loss is an allowable capital loss that you can use to reduce your capital gains income from investment sources.
Generally, you cannot reduce your capital gains income with a superficial loss.
However, you can include the superficial loss in your adjusted capital base calculation when determining the capital gain or loss you incur when you sell the repurchased identical property in the future.
Avoiding Superficial Losses
You can avoid a superficial loss if you sell a capital property to an independent person who has no relation with you in an arm’s length transaction.
Also, you need to ensure that you or an affiliated person disposes of a capital property or the right to buy the capital property before the 30 days after you sold the property.
For example, suppose you dispose of capital property and incur a capital loss of $10,000 on January 1.
If you repurchase the property or an identical property on January 25, that is, 24 days from the sale, you can trigger a superficial loss.
This means that you cannot claim 50 percent of the $10,000 loss.
However, if you resell this repurchased capital property to a third-party before 30 days from your first sale, which is January 31, you can claim the capital loss from the first sale.
Non Superficial Loss
The CRA does not consider the following transactions as a superficial loss:
- If you sold a capital property because you became or ceased to be a resident of Canada.
- If you sold the property because you changed its use.
- If you disposed of the property, and within 30 calendar days after the disposition, you became or ceased to be exempt from income tax.
- If the property sale is due to an option expiring.
- If the property is appropriated due to the winding up of a corporation.
- If a corporation, partnership, or trust disposes of non-depreciable capital property.
- If the property is sold due to the death of the owner.
Frequently Asked Questions
- Does the superficial loss rule apply to options?
A call option gives you the right to purchase capital property at a specific price and date. If you have a call option on capital property after you have sold it and incurred a capital loss, you can trigger a superficial loss.
- Does superficial loss apply to crypto?
Superficial loss applies to all capital property, including crypto assets held as capital property. A cryptocurrency is capital property if not held for business or commercial purposes. If you dispose of a crypto asset held as capital property, you can incur a capital gain or loss. If the transaction meets the conditions of a superficial loss, it will be treated as such.