Loss Trading in the Time of COVID-19: The Stop-Loss Rules and the Superficial Loss Rule
COVID-19 has created uncertainty in equity markets and the economy generally. The value of capital investments in stock held as portfolio investments or shares in privately owned corporations, in particular, are threatened as all manner of businesses face financial difficulty.
As stock prices and share values dip, many investors may be seeking to sell their stock and may realize a capital loss in doing so. It will, therefore, be imperative to keep in mind both the superficial loss rule and the stop-loss rules if investors hope to obtain the use of any triggered capital losses in doing so.
We caution that this is article presents a high-level overview of these complex rules. We are here to help you in applying these rules to your particular fact scenario. This article assumes that a person is not in the business of trading in securities or buying and selling stock.
The term “affiliated” is used below. Affiliated persons to an individual include his/her spouse or common-law partner, or a corporation that the individual or his/her spouse or common-law partner controls.
Corporations controlled by the same person or group of persons are also affiliated. There are other scenarios where persons or entities are affiliated.
Selling Publicly Traded Shares or Other Securities That Are in a Loss Position
Where you or your corporation purchase stock in a publicly traded corporation, fund, or another publicly traded entity and the value decreases, typically the stock can be sold in order to crystallize a capital loss. The amount of the loss, which very generally, is the amount of the decrease in value of the stock between the time it was purchased and the time of the sale (but if securities were purchased at different times, the cost of each particular share is averaged), can be used to offset realized capital gains. By doing so means a lower amount of capital gains tax will be payable.
There is an obvious temptation to sell stocks that have decreased in value to create a capital loss and then re-buy the same stocks so as not to lose the benefit of owning them, such as the potential for future growth or the opportunity to be paid dividends. However, selling and re-buying too quickly will result in the application of what is called the superficial loss rules for vendors who are individuals and the stop-loss rules for vendors which are corporations
The relevant set of rules is triggered if you or your corporation (the “vendor”) sell stock and:
(a) The vendor or a person affiliated with the vendor, acquired the stock or identical stock during the 30 days before or the 30 days after the stock was sold; and
(b) The vendor or a person affiliated with the vendor, owns the stock at the end of the 30 day period following the sale.
If the superficial loss rules or stop-loss rules are triggered, the capital loss that would otherwise have been triggered on the sale of the stock will be denied. Under the stop-loss rules, the denied loss is “suspended” in the hands of the vendor. This means that when the vendor or affiliated person who purchased the shares ultimately sells them to a non-affiliated party, the vendor may be entitled to claim the capital loss that was suspended. Under the superficial loss rules, the amount of the denied loss is added to the cost base of the stock of the affiliated party, so the vendor or the affiliated party will have either a smaller capital gain or larger capital loss when they ultimately sell the shares.
Selling Private Company Shares or Other Assets That Are in a Loss Position Within an Affiliated Group
These shares cannot be sold on the open market in the same way as publicly traded stock. Accordingly, you might arrange for a person with whom you or your corporation is affiliated with to buy the shares. Here also the superficial loss rules will apply in the same manner to vendors who are individuals and the stop-loss rules will apply in the same manner to vendors who are corporations.
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We recognize the significant economic and personal consequences facing our clients at this time. Fillmore Riley's taxation team is available to help. Our key contact is Cy Fien.