What is an apparent loss?
You can suffer an apparent loss if you have an immobilization and if the following two conditions are met:
-
- You or someone affiliated with you buys or has the right to buy the same or identical good (called “replacement good”) within 30 calendar days before or after the transaction.
- You or a person affiliated with you still own or have the right to acquire the replacement good 30 calendar days after the transaction.
Why is there a rule for apparent losses?
The purpose of the superficial loss rules in the Income Tax Act (ITA) is to deny the deduction of capital losses on the disposition of property if the taxpayer acquires the same or an identical property before the expiry of a specified period. Essentially, these rules are designed to prevent you from generating capital losses that could be used to offset capital gains, and then repurchasing, within a short period of time, the property that generated the loss or an identical property.
Apparent loss rules may apply, in particular, if :
- you sell a property at a loss;
- you or an “affiliated person” acquire the good or an identical good (“replacement good”) within the period beginning 30 days before the sale and ending 30 days after the sale (the “relevant period”);
- you or an affiliated person hold the replacement property at the end of the relevant period.
However, the loss is not necessarily “lost” forever, since the amount is added to the cost of the replacement property. Thus, if the replacement property is sold later, some or all of the loss may be realized at that time (assuming that the superficial loss rules do not apply to the later sale).
What is an affiliate?
An “affiliated person” includes your spouse or common-law partner. It also includes a company controlled by you or your spouse, or by an affiliated group of persons of which you or your spouse are a member. An affiliated person also includes a partnership in which you hold a controlling interest, or a trust of which you are a majority interest beneficiary (which may include an RRSP or RRIF). Interestingly, an affiliated person does not include your child or other close relative.
What is an identical good?
The term “identical property” is not defined in detail in the ITA. The Act states, however, that a bond, debenture, bill or other comparable security issued by a debtor is identical to another similar security issued by that debtor if the two are identical in all rights except for the principal amount of the security.
In addition, the following comments are generally accepted by the Canada Revenue Agency (“CRA”) and most tax professionals:
- Shares in a company are identical if they belong to the same class. Shares of two different classes of the same company are not considered identical, even if shares of one class can be exchanged for shares of the other class or converted into shares of the other class.
- Shares in two different companies are not identical, even if the companies are very similar.
- Mutual fund units are identical only if they are units of the same fund.
Would some examples help you understand?
Find out more...
Example
You sell 1,000 common shares of X Ltd. on the open market for $50,000 and realize a capital loss of $10,000. Ten days later, your spouse buys 1,000 common shares of X Ltd. for $50,000. Two months later, your spouse sells the shares for $52,000 and neither you nor your spouse redeem the shares.
You are denied the $10,000 capital loss deduction because your spouse acquired the replacement property (common shares of Xco) in the relevant period and held them at the end of the period. However, the loss is added to your spouse’s cost of shares, which becomes $60,000. As a result, on the subsequent sale for $52,000, your spouse realizes a capital loss of $8,000. In fact, this $8,000 loss reflects your original $10,000 loss, less the $2,000 gain that accumulated on the shares while they were held by your spouse.
If your child had acquired the shares instead, you would immediately realize a capital loss of $10,000. Upon subsequent sale by your child, there would be a capital gain of $2,000.
If you or the affiliated person acquire only a portion of the property, a pro rata portion of the loss is disallowed.
Example
You sell 1,000 common shares of X Ltd. on the open market for $50,000 and realize a loss of $10,000. Ten days later, you buy 500 shares of X Ltd. for $25,000. Two months later, you sell the 500 shares for $28,000.
You are denied the deduction of half of your original capital loss of $5,000 because you redeemed half of your original 1,000 shares in the relevant period and held them at the end of the period. The other half of your initial loss can be deducted.
The disallowed loss of $5,000 is added to your cost of the 500 shares redeemed, which becomes $30,000. So when you later sell these shares for $28,000, you realize a capital loss of $2,000.
It’s possible to avoid having the rule apply to you!
As you can see, since the rule provides for a specific 30-day period, you can avoid its application if you (or the affiliated person) reacquire the property after the end of the period. For example, if you want to show some capital losses on shares near the end of a tax year to offset capital gains, you can sell the shares and buy them back 31 days later without worrying about the superficial loss rules. (Obviously, the longer you wait, the greater the likelihood that the share price will have risen in the meantime).
What about corporations, trusts and partnerships?
The rules described above apply to private individuals. They are somewhat different when a corporation, trust or partnership (“transferor”) has an apparent loss. Even if the loss deduction is refused, the amount of the loss is not added to the cost of the replacement property. Instead, the loss deduction is suspended, and may be claimed by the transferor when neither the transferor nor an affiliated person holds the replacement property (technically, the loss deduction is claimed at the beginning of the first 30-day period during which neither the transferor nor an affiliated person holds the replacement property).
If you have any questions, please contact us by clicking here.
