The Income Tax Act has special guidelines for the type of loss known as a “superficial loss”. These rules are meant to prevent tax avoidance and prevent the deduction of artificial losses created on paper by people who are not dealing at arm’s length, meaning two people who not fully independent from one another. These are rules you should know if you are buying or selling capital property.
What Qualifies as Capital Property?
Capital property is any property that can create capital gains or losses when you dispose of it. This includes land, shares, bonds, funds and trust units, tangible items such as vehicles or buildings, and intangible property such as patents and trademarks, as well as fixed and circulating assets.
Capital Gains and Losses
To understand superficial losses, you must first know what a capital gain or loss is. Capital gains or losses occur when you dispose of capital property such as real estate, precious metals or shares.
- When you sell capital property at a gain, you must report 50 percent as income.
- If you have a capital loss, you can use it to offset capital gains you have elsewhere to lower your taxes.
In this context, it can be tempting to create a loss by disposing, on paper, of a property that has lost value while not really disposing of the property in actuality. This is where the superficial loss rules come into play.
A superficial loss occurs when you dispose of capital property for a loss and you, or a person affiliated with you, buys, or has a right to buy the same or identical property during the period starting 30 calendar days before and ending 30 calendar days after the sale.
The meaning of identical property varies by type of property, but it generally means properties that are the same in all material respects.
- Two gold bars are identical even if they have different serial numbers.
- However, two cottages located in different places are not considered identical, even though both are cottages.
In these circumstances, the loss is called a superficial loss and is not deductible.
You cannot claim a superficial loss on your tax return
Say you purchased a building for $200,000 and sold it for $100,000, you would incur a capital loss of $100,000. You can use this loss to offset income from capital gains on your income tax return including the year of disposition, or you can carry the loss back three years or forward indefinitely.
However, if you sold the building in December but you had an arrangement to buy it less than 30 days later in January, you could not claim the loss as a capital loss on your income tax return. This is a superficial loss, and the CRA does not allow you to claim it.
Similarly, if your spouse, your child or another person affiliated with you arranged to buy the property within that time period, the loss would also be superficial, and you would not be allowed to claim it.
There are exceptions to this rule, but any time you sell a property and you or someone close to you reacquires it or one that is similar, the transaction should be analyzed to see if the superficial loss rules might apply.