This article discusses some considerations in the tax treatment of:

• Allowable capital losses;
• Allowable business investment losses; and
• Non-capital losses.

Allowable Capital Losses

You have an allowable capital loss when you sell, or are considered to have sold, a non-depreciable capital asset (say an investment or real estate) for less than its adjusted cost base plus the outlays and expenses involved in selling the property. In other words, the capital loss arises because the amount realized from the sale of the asset is less than its purchase price. The allowable capital loss is deducted against any taxable capital gains you have. Generally, one-half of the capital loss can be offset against one-half of the capital gain. However, allowable capital losses usually cannot be offset against other income sources, such as business income or earned income.

The adjusted cost base is usually the cost of a property plus any expenses you incurred to acquire it, such as commissions and legal fees. The cost of a capital property is its actual or deemed cost, depending on the type of property and how you acquired it. Cost also includes capital expenditures for additions and improvements. However, you cannot add current expenses, such as maintenance and repair costs, to the cost base of a property.

Some capital losses, such as the loss on personal-use property, cannot be claimed for tax purposes. For example, if you sell the family cottage at a loss, the loss will be denied for tax purposes.

Allowable capital losses can be used to reduce your taxable capital gains in the year the loss was realized, carried forward to future years or applied to previous gains. For example, if you sell a non-registered investment (one that is not held in your RRSP) at a capital loss and the loss cannot be used in the current year, the loss (referred to as a net capital loss) can be:

• Carried forward indefinitely to reduce the taxable capital gains in the future; or
• Carried back three years and applied to taxable capital gains in those years.

When you apply a net capital loss back to a previous year's taxable capital gain, it will reduce your taxable income for that previous year. However, your net income, which is used to calculate certain credits and benefits (such as the child tax benefit or the clawback of Old Age Security) will not change.

There are additional tax implications for a loss from the sale of a depreciable property (for example, a rental property). Certain rules on capital cost allowance (CCA) may require the recapture of CCA to be added to your income or allow you to claim a terminal loss.

Taxpayers are often remiss at providing their chartered accountant with sufficient documentation about capital acquisitions and dispositions to ensure that they can take advantage of any capital losses. To be able to claim a capital loss, you will need to keep careful records, including:

• A description of the capital property, purchase price and date of purchase;
• Documentation of any borrowings, including payments and interest charges, that were used to finance the purchase;
• Any costs incurred for the purchase of the capital property (legal fees, brokerage fees, transfer fees, etc.); and
• Documentation and details of the sale, including price, date and any costs incurred.

An ABIL is one-half of the loss on the disposition of shares or debt of a small business corporation.

To qualify as an ABIL, certain conditions must exist.

• The company must be a Canadian-controlled private corporation, where all or substantially all of the fair market value of its assets are used principally in an active business that is carried on primarily in Canada by the corporation or by a corporation related to it.
• The assets of the corporation can also include shares of, and/or a debt issued by, other eligible small business corporations or a combination of business assets, shares, and debt; and
• The corporation must have been a small business at any time in the last 12 months before the sale or loss.

A loan made to a corporation, which becomes uncollectable, is considered an ABIL as long as the other conditions are met. This loss can be claimed when the debt is established to be a bad debt.

Non-capital Losses

Generally, a non-capital loss for a particular year includes any loss incurred from employment, property or a business to the extent that it exceeds your other sources of income for the year. An ABIL realized in the particular year is also included in your non-capital loss.

Non-capital losses can be carried back 3 years or carried forward 7, 10 or 20 years against any income in those years, depending on when the loss was realized.

The carry-forward periods are:

• For taxation years ending March 22, 2004 or earlier, 7 years.
• For taxation years ending after March 22, 2004, 10 years.
• For taxation years ending after 2005, 20 years.

The 20-year carry-over period for non-capital losses can be especially helpful for small businesses, as new enterprises often experience several years of losses during their start-up phase.

Note, however, that the 20-year carry forward does not apply to a non-capital loss resulting from an ABIL. Instead, an ABIL that has not been used within 10 tax years will revert to a net capital loss in the 11th year. After that time, it can only be applied against future taxable capital gains.

Before You Act

Individuals and corporations may be able to realize certain tax benefits to help offset the impact of capital and non-capital losses. However, while you may be tempted to gain some tax benefit from your losses, be sure to talk to your chartered accountant before taking any action. The tax treatment and implications can be very complicated.