24.3.3 Capital Losses

Overview

A capital loss occurs when a security is sold for less than its cost. Capital losses are calculated in the same manner as capital gains and can generally be deducted from capital gains. This chapter explains how capital losses are treated under Canadian tax law, including types of special capital losses such as worthless and superficial losses.

Calculation of Capital Losses

Example

Stanley sold shares in his bank stocks for a $5,250 capital gain. That same year, Stanley’s computer tech stocks dropped in value, and he sold the shares for a capital loss of $3,000. Normally, Stanley would pay tax on $2,625 of his capital gain ($5,250 gain × 50%), but he is permitted to deduct $1,500 of the allowable capital loss ($3,000 loss × 50%) from that amount. Because of this deduction, Stanley will pay tax on only $1,125 ($2,625 taxable capital gain – $1,500 allowable capital loss). Allowable capital losses that cannot be used in the tax year can generally be carried back three years or carried forward indefinitely to offset taxable capital gains in other years. However, allowable capital losses can only offset taxable capital gains and not other income.

Special Cases: Worthless Securities and Superficial Losses

Worthless Securities

When a security becomes worthless, the holder must complete a CRA form declaring the security worthless to realize the capital loss for tax purposes. This rule does not apply to instruments with an expiry date, such as warrants, rights, or options. For these instruments, investors can claim capital losses after they expire without a declaration. An exception occurs when a security becomes worthless due to the underlying company’s bankruptcy or insolvency. In these cases, the Income Tax Act deems the taxpayer to have disposed of the security for nil proceeds and reacquired it at a cost of nil.

Superficial Losses

A superficial loss happens when securities sold at a loss are repurchased within 30 calendar days before or after the sale and are still held at the end of 30 days after the original sale. Superficial losses are not deductible as capital losses. However, they may be deferred rather than lost entirely. The superficial loss rules prevent taxpayers from creating deductible capital losses without any meaningful change in ownership.

Example: Superficial Loss

Pierre buys 100 XYZ shares at $30 per share in mid-April and sells the shares at $25 per share on May 1. He incurs a $500 capital loss (calculated as $3,000 – $2,500). Typically, an allowable capital loss of $250 (50% of $500) would be deductible against taxable capital gains. However, the superficial loss rule applies in the following scenarios: Scenario 1:

• On May 15, Pierre reacquires 100 XYZ shares at close to $25 per share and holds them until July.
• Since the transaction was within 30 days after the May 1 sale and shares were held for 30 days post-disposition, the loss is considered superficial. Scenario 2:
• On April 29, Pierre acquires 100 XYZ shares near the initial $30 per share purchase price.
• He sells 100 XYZ shares on May 1 at $25 per share but still holds 100 shares until July.
• The loss is also considered superficial as shares were acquired less than 30 days before the sale and held for at least 30 days post-disposition. Superficial loss rules apply not only to the investor but also to the following related parties:
• The investor’s spouse or common-law partner
• Corporations controlled by the investor or spouse
• A trust in which the investor is a majority interest beneficiary Superficial losses are non-deductible but can be added to the cost base of repurchased shares, thereby reducing future capital gains.

Example of Superficial Loss

Using the previous example, if Pierre’s $500 capital loss was superficial, and he reacquired the shares at $25 per share before May 31, the $5 per share loss would add to the cost base of the 100 shares owned on May 31. If these shares sell later at $40 per share, the capital gain calculation is:

• \(\text{Proceeds from disposition} = 100 \times 40 = 4,000 \)
• \(\text{Less: Cost of repurchasing shares} = 100 \times 25 = 2,500 \)
• \(\text{Superficial loss} = 100 \times 5 = 500 \)
• \(\text{Commission on purchase} = 45\)
• \(\text{Subtotal} = 955 \)
• \(\text{Less: Commission on sale} = 60 \)
• \(\text{Capital gain} = 895 \)
• \(\text{Taxable capital gain} (50% of 895) = 447.50\)

Exceptions to Superficial Loss Rules

Superficial loss rules do not apply in the following circumstances:

• The investor emigrates from Canada
• The investor dies
• An option expires
• A deemed disposition of securities by a trust occurs
• The securities are sold to a controlled corporation

Key Takeaways

• Capital losses occur when securities are sold for less than their adjusted cost base (ACB).
• Allowable capital losses can offset taxable capital gains and can be carried back three years or forward indefinitely.
• Superficial losses, arising from repurchased securities within 30 days, are non-deductible but can be deferred.
• Worthless securities can realize capital losses with a CRA declaration.

For more details, consult the Canadian Revenue Agency (CRA) and the Canadian Securities Institute websites."