The rituals of year-end tax-loss selling, Part 2

The mysteries of superficial loss rules and ABILs

The year-end ritual of tax-loss selling is upon as again. This is the strategy whereby you sell losing investments in order to use the capital loss to shelter capital gains elsewhere. Last time, I looked at some of the key rules of tax-loss selling, including when and how to claim losses, and where you might look for tax losses, including those carried forward from previous years. But that’s not the end of the story. There are a few other things you should know, including the superficial loss rule trap, the mutual fund conundrum, and the mysteries of the ABIL rules.

Eat your cake and have it too

One complication of tax-loss selling occurs if you in fact want to hold on to a losing investment for some reason or other, but feel you need to use the capital loss this year. If you’re thinking of selling and buying back in again, beware the “superficial loss rules.” These rules can knock out a tax loss if you’re selling to take a loss, and then buy an identical investment within 30 days before or after the sale and continue to hold it at the end of the period. The CRA watches closely for this little manoeuvre, and won’t allow it. Either wait until after the 30-day period to buy back into the investment or have another family member (other than a spouse) buy it back if you want in again. These rules apply only if you buy an identical investment within the 3-day period. So, for example if you sell Royal Bank and buy Bank of Montreal, you’re okay, taxwise at least.

Mutual fund conundrum

If your mutual fund is in a loss position, one way to trigger a tax loss is to convert to another fund within the fund family, for example, from a Canadian equity to a U.S. equity or money market fund (as always, tax losses can’t be claimed if the investment is in your RRSP or TFSA).

However, some funds have been set up in what’s called a “corporate class” structure, so that when a switch takes place, no gain or loss recognized for tax purposes (of course, the idea behind this type of structure is to defer capital gains). This should be checked out before you make the conversion.

The mysteries of the ABIL rules

Losses from investments in “private” corporations devoted to Canadian business may qualify as “allowable business investment losses” (ABILs), which is a fancy term that means your tax loss can be deducted against all sources of income, not just capital gains. (As is the case with capital gains/losses, 50% of the actual loss can be deducted.) In many cases, Canadian “over-the-counter” shares may qualify.

But be careful! ABIL claims are closely monitored by the CRA, so you should be in a position to back up your claim. Basically, the corporation’s assets must be devoted to Canadian active business activities. Also, to the extent that you’ve claimed the capital gains exemption in prior years, the ABIL will turn back into a garden-variety capital loss.

Business or pleasure?

In some cases, you could be treated as being “in the business” of trading investments. If so, 100% of your losses are deductible against all sources of income, not just capital gains. In fact, it may often be possible to claim a loss by “writing down” the investments to their value if this is less than their original cost (the investments must be “written back up” if they recover in value). But before you file on this basis, you’d better make sure you can back up your claim that you’re actually in the “investment business.” Tax, legal, and accounting help is highly recommended here.

Deducting capital gains

The capital gains deduction can be applied against taxable capital gains that arose from the following:

* Dispositions of qualified small business corporation shares.
* Dispositions of qualified farm or fishing property.
* Reserves brought into income from any of the above.

The capital gains deduction cannot be applied to taxable capital gains arising from dispositions of publicly-traded shares and mutual funds, and other gains that are reported in sections 3 to 8 of Schedule 3.

If you disposed these type of properties while you were a nonresident of Canada, the capital gains are not eligible for the capital gains deduction. For more information on what constitutes a resident of Canada, see “Who is eligible to claim the capital gains deduction?” on the CRA website. Note: Deferred capital gains on the disposition of qualified small business corporation shares do not qualify for the capital gains deduction.

Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3^rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. Portions of this article first appeared in The TaxLetter, © 2019 by MPL Communications Ltd. Used with permission.

Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.