The year-end hunt for tax losses

Business and non-capital losses can help slash your tax bill

Investment capital losses are not the only types of losses you can use to cut your tax bill. In my previous article, I looked at how and when to use capital losses to offset capital gains, and how to determine whether you really have a loss to begin with. This time, I’ll look at where to find other kinds of losses, including allowable business investment losses, and how to use non-capital losses to reduce this year’s tax bill.

Finding your losses

When hunting for losses, check to see whether you incurred capital losses in a previous year that you have never used. This is quite possible because deductions for capital losses can only be claimed against capital gains, and unclaimed capital losses can be carried forward indefinitely. If you don’t have back records, another idea is to contact the Canada Revenue Agency (CRA) to request your personal “carryforward balances.”

Other possibilities for tax losses include bad loans (including such items as bad mortgage investments, junk bonds, a no-good advance to your company, bad loans to a business associate, and so on). Finally, if applicable, check your 1994 return to see whether you have made the “last chance” election to take advantage of the now-defunct $100,000 capital gains exemption. For most investments, this will result in an increase to the cost base of the particular item.

If your gain is on a mutual fund and you made the election on it, you may have a special tax account – known as an “exempt capital gains balance” – which can be used to shelter capital gains from the fund until the end of this year, after which it must be added to the cost base of the particular investment.

Here are some other things you should know about tax-loss selling:

Hanging in. One complication when it comes to tax-loss selling occurs if you want to hold on to the investment. But if you’re thinking of selling and buying back in again, watch out for the “superficial loss rules.”

These rules can knock out a tax loss if, when selling to take a loss, you buy an identical investment in the period within 30 days before or after the sale and you continue to hold it at the end of the period. Either wait until after the 30-day period or have another family member (other than a spouse) buy back the investment – if you want in again. These rules apply only if you buy an identical investment within the 30-day period. So if you sell, say, shares of Royal Bank and buy, say, Bank of Montreal, you’re okay, from a tax standpoint at least.

Mutual funds. If your mutual fund is down, one way to trigger a tax loss is to convert to another fund within the family, for example, from a Canadian equity fund to a U.S. equity or money market fund (as always, tax losses can’t be claimed if the investment is in your RRSP). However, some most fund companies offer “corporate class” structures of funds that have been set up so that, when this conversion takes place, there is 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.

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 investment to its value if this is less than its original cost (the investment must be “written back up” if it recovers in value). But before you file on this basis, you’d better make sure that you can back up your claim that you’re in the “investment business.”

Watch foreign currency effects. When assessing whether you’re in a loss position, don’t forget that capital gains are calculated in Canadian dollars – so currency fluctuations can be a key consideration. If the Canadian dollar has appreciated against the currency there will tend to be losses.

ABILs

Losses from investments in “private” corporations devoted to Canadian business may qualify as “allowable business investment losses” (ABILs), a fancy term that means that 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 shares traded “over-the-counter” may qualify. Warning: 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.

Non-capital losses

If you happen to be carrying on a business (whether personally or through a corporation), it’s possible that you may be generating “non-capital losses.” Generally, a non-capital loss for a particular year includes any loss incurred from employment, property, or a business. So, if your business didn’t generate more income than your expenses in the year, you may have a business loss (that is, a non-capital loss), or if your rental property stood empty for a few months last year despite your best efforts to find tenants, you may have a rental loss (a non-capital loss).

If at the end of your taxation year you are in the red, the resulting non-capital loss can be carried back three years against previous years’ income (and claim a tax refund), or carried forward to be applied to the income from your other sources such as employment, RRSP income, interest amounts, etc. The number of years to carry the loss forward will depend on when the loss was incurred, as follows:

For taxation years ended March 22, 2004, or earlier, you can carry forward such losses for seven years.
For taxation years ended after March 22, 2004, you can carry forward such losses for 10 years.
For taxation years ended after 2005, you can carry forward such losses for 20 years, except ABILs. Instead, a non-capital loss resulting from an ABIL arising in tax years ending after March 22, 2004, that has not been used within 10 tax years will continue to become a net capital loss in the eleventh year.

Furthermore, a non-capital loss resulting from an ABIL arising in tax years ending prior to March 23, 2004, which was not used within seven tax years, becomes a net capital loss in the eighth year (which means it can only be used offset capital gains).

But be careful when calculating that 20-year period if the business is being carried on by a corporation.

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. This article first appeared in The TaxLetter, © 2021 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.