Advisors understand that on death, a Canadian resident is deemed to dispose of their assets at fair market value, often resulting in capital gains being triggered.  However, in some instances, capital losses may result.

The legal representative of the estate should seek tax advice early if capital losses are triggered on death or if the deceased has capital losses from previous tax years.  There may be a strategic opportunity to use the capital losses to the benefit of the estate and beneficiaries.

Capital Losses

For capital losses, the general rule is that they can only be deducted against capital gains.  If the capital losses exceed the capital gains in a specific tax year, the net capital loss (that is, currently, fifty per cent (50%) of the excess amount) may be carried back three (3) years and carried forward indefinitely.

Interestingly, in the year of death, there’s a special rule[1] that may potentially allow the use of capital losses against any other income.  I must point out that there are criteria to be followed beforehand such that:

• If the deceased had capital gains in the year of death, any capital losses triggered in the year of death or carried forward from previous years will first be applied against those capital gains.
• The remaining net capital losses are then reduced by any capital gains deductions the deceased person claimed in all previous years. The remaining net capital losses may then be applied against any other income for the year of death (not just capital gains).
• Further, any remaining net capital losses may be applied against any other income for the immediately preceding year.

and

• If the capital losses were realized in the year of death, then any remaining net capital losses may be carried back two (2) further years to be applied against capital gains for those years in the normal way.

Electing Out of the Rollover?

If the terms of the Last Will provide for the residue of the estate to be distributed to the surviving spouse, the executor may need to purposely trigger capital gains (by electing out of the spousal rollover) in order to apply the capital losses against such capital gains.

What About the Superficial Loss Rules?

The superficial loss rule refers to a section of the Income Tax Act[2] that denies a capital loss where a capital property is disposed of, triggering a capital loss, and the same or identical property (the “Substitute Property”) is purchased by the taxpayer or a person affiliated with the taxpayer within 30 calendar days before or after the disposition. Such capital loss is deemed a superficial loss and it cannot be used to offset realized capital gains. The loss will be suspended until the Substituted Property is no longer with the affiliated person (or affiliated group).

Since an affiliated person is defined to include the deceased’s spouse or partner or a trust for the benefit of the deceased’s spouse or partner, the superficial loss rule may be triggered if the deemed disposition of property on death would result in a capital loss.

However, the superficial loss rule does not apply in the context of a deemed disposition on death because of a specific relieving provision[3] under the Income Tax Act.  As a result, the capital loss can be applied against capital gains as stated above.

Conclusion

If capital losses result on the death of a taxpayer, the legal representative ought to seek tax advice as there may be some opportunity to apply those capital losses against capital gains triggered in the year of death, in the preceding year and possibly, the two (2) years preceding the preceding year of death.

[1] Subsection 111(2)

[2] the definition of superficial loss in section 54

[3] Paragraph (c) of the definition of superficial loss in section 54.