If you have purchased and sold investments such as cryptocurrency, stocks, mutual funds, or other capital property, you may be subject to adverse tax consequences through the superficial loss rule. Although many taxpayers are not familiar with the superficial loss rule, the CRA still assigns the responsibility of correctly tracking and reporting the implications of this rule solely to the taxpayer.
The superficial loss rule denies a capital loss when you sell and repurchase the same or identical property within a short period of time. According to the Canada Revenue Agency (CRA):
“A superficial loss can occur when you dispose of capital property for a loss and both of the following conditions are met:
You, or a person affiliated with you, buys, or has a right to buy, the same or identical property (called "substituted property") during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale.
You, or a person affiliated with you, still owns, or has a right to buy, the substituted property 30 calendar days after the sale.
Some examples of affiliated persons are:
you and your spouse or common-law partner
you and a corporation that is controlled by you or your spouse or common-law partner
a partnership and a majority-interest partner of the partnership
after March 22, 2004, a trust and its majority interest beneficiary (generally, a beneficiary who enjoys a majority of the trust income or capital) or one who is affiliated with such a beneficiary”
If you incur a superficial loss, you cannot deduct the loss when you calculate your income for the year. However, you can usually add the amount of the superficial loss to the adjusted cost base of the property that was repurchased. This will either decrease your capital gain or increase your capital loss when you sell the property in the future. This rule prevents aggressive tax planning that involves selling and repurchasing capital property for the purpose of crystallizing accrued losses on property a taxpayer still wishes to own.
Superficial Loss Example
A simplified example of when a superficial loss will occur is if you dispose of 1 Bitcoin at a $1,000 loss and you, or your spouse repurchases 1 Bitcoin at any time during the period starting 30 calendar days before the date of settlement and ending 30 calendar days after the date of settlement. The $1,000 loss would be denied and added to the cost base of the 1 Bitcoin purchased.
Taxpayers may need to report higher income on their tax returns than was otherwise expected if they are subject to the superficial loss rule. Even though the taxpayer realized the loss, the superficial loss rule may deny all or part of the deduction for the loss. Therefore, it is important to keep the implications of the superficial loss rule in mind when buying and selling capital property.
Identical Properties Rule
Moreover, it is important to note that the superficial loss rule does not only apply to transactions of the exact same property. The superficial loss rule instead applies more broadly to “the same or identical properties”. In IT-387R2 the CRA provides a general meaning of the term “identical properties”:
“¶ 1. "Identical properties", for the purposes of subsection 47(1), the definition of "superficial loss" in section 54 of the Act and subsection 26(8) of the ITAR (and subject to the provisions referred to in ¶ 5 and ¶s 9 to 11), are properties which are the same in all material respects, so that a prospective buyer would not have a preference for one as opposed to another. To determine whether properties are identical, it is necessary to compare the inherent qualities or elements which give each property its identity. Such a determination is a question of fact which must be decided on the basis of the relevant details in each situation.
¶ 2. The identical nature of properties is not affected by the fact that ownership is evidenced by means of certificates which may represent different quantities of the properties, as in the case of share certificates or gold certificates.
¶ 3. Two properties which are otherwise identical do not cease to be so merely because one is subject to a charge or other external condition which may affect its price and the other is not, provided the external condition does not change any of the constituent elements of the particular property (e.g., provincial retail sales tax, commission fees).”
Therefore, taxpayers must be careful to consider if the property purchased and sold could fall within the definition of “identical properties” for purposes of the superficial loss rule. For example; in regard to cryptocurrencies, if one type of USD stable coin was sold for a loss and another type of USD stable coin was purchased briefly after the sale, you would need to consider whether this transaction would fall within the definition of “identical properties” for purposes of the superficial loss rule.
Partial Superficial Loss
You may choose to calculate a partial superficial loss rather than apply the full superficial loss in instances when a partial disposition/repurchase of capital property occurred within the superficial loss period. This may result in a portion of the loss being deductible for tax purposes which will lower your taxable income. The CRA has outlined a specific formula for calculating a partial superficial loss in Technical Interpretation 2004-0073011E5 – Superficial Loss. The CRA states:
“When fewer items are bought during the period described in the definition of "superficial loss" than were sold during that period, the Canada Revenue Agency administratively accepts that the amount of the "superficial loss" may be determined by using the following algebraic formula:
SL = (Least of S, P and B)/S x L
where
SL is the superficial loss, S is the number of items disposed at that time, P is the number of items acquired in the 61-day period, B is the number of items left at the end of period, and L is the loss on the disposition as otherwise determined.”
Exceptions to the Rule
There are instances where the superficial loss rule does not apply. You may find a list of common instances where the rule would not apply by clicking here.
Tracking Transactions
If you trade on multiple platforms and/or trade cryptocurrencies, you may need to track the adjusted cost base of your investments manually. Traditional methods of tracking transactions can be time consuming and inaccurate, especially when considering the implications of the superficial loss rule. As you can see from the partial superficial loss rule formula above, calculating superficial losses manually can be a very difficult and meticulous task. It is recommended to use a reputable software to help automate the process. Using software will greatly improve the efficiency and accuracy of how transactions are recorded. It is important to ensure the software you are using has correctly integrated the superficial loss rule within its functionality. For tracking cryptocurrency transactions, we recommend using a software such as Cointracking.info.
Always Consult an Expert
This is only a general overview of some common components of the superficial loss rule. We recommend consulting the advice of an expert to evaluate the complete implications of this rule and identify potential tax planning opportunities such as utilizing the superficial loss rule to transfer losses to a spouse in certain instances. TSB Chartered Professional Accountant Inc. are leaders in Canadian investment/cryptocurrency taxation and are available to analyze your tax situation.
Tristan Bagri, CPA
Founder & Director
Tristan@tsbcpa.ca
778-707-4699
Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing. You should consult with a Chartered Professional Accountant when evaluating your tax situation.