Capital Losses in the Year of Death: Final Return Rules in Canada

When someone dies, the tax system treats them as having sold their capital property just before death. Most people think of that as a tax bill, but if a property has dropped in value, it can create a loss that is useful to the executor.

This article explains how those losses are reported, how the year of death gives them extra reach, and how losses the estate realizes later may be brought back to the final return. Your facts will matter, so treat this as general information and confirm details with a lawyer or accountant.

This article covers Canadian federal tax law, which applies in every province.

How a loss arises at death

On death, the person is deemed to have disposed of each capital property immediately before death for proceeds equal to its fair market value. The final return, not an inheritance tax, carries the result.

Gain or loss is the fair market value on the date of death minus the adjusted cost base. It is reported on Schedule 3 and line 12700 of the final return, and the deceased reports it, not the beneficiaries. If the adjusted cost base is higher than the value at death, the result is a loss.

The CRA generally describes fair market value as the highest dollar value you can get for property in an open and unrestricted market. Keep records that support the value on the date of death.

The special year-of-death loss rule

Net capital losses on the final return and on the prior year's return can offset income other than capital gains, which is not normally allowed in other years. That can matter where the deceased had employment, pension, RRSP or other income.

Net capital losses of other years are claimed on line 25300 of the final return. Section 111(2) of the Income Tax Act changes the usual carry-forward rule for the year of death, so unused net capital losses for all taxation years that are not otherwise claimed may be deducted in computing taxable income. The exact reach of this rule is worth confirming against the statute with your adviser.

• Schedule 3 and line 12700 report the deemed disposition.
• Line 25300 is where net capital losses of other years are claimed.
• Losses from the final return year and the prior year can offset non-gain income.

Losses the estate realizes after death

Gains on property the estate sells after death are reported on the estate's T3 Trust Income Tax and Information Return, not on the final return. Capital gains go on T3 line 1, using T3 Schedule 1.

Where the estate is a graduated rate estate and sells capital property in one of its first three taxation years, its capital losses may exceed its gains. In that case the legal representative may elect under s. 164(6) to treat part of the excess as the deceased's loss on the final return. The election is made by the estate's filing due date for that year, and the final return must be amended.

Before relying on this, check the carry-back period and conditions in the statute, since they vary by situation and may depend on how the estate qualifies.

Electing out of the spousal rollover to use losses

Property passing to a spouse or common-law partner resident in Canada generally rolls over at the adjusted cost base, so no gain or loss arises on the final return. A qualifying spouse trust can also qualify, and the property must vest indefeasibly within 36 months after death unless the Minister allows longer.

The legal representative may elect in the final return that the rollover not apply, so the regular deemed disposition applies instead. The CRA says the election is made property by property, and proceeds are then set at fair market value. This can create gains on the final return that absorb losses, and can be useful to use the deceased's losses, the capital gains deduction or lower rates.

Timing and next steps

For a death from January 1 to October 31, filing and the balance owing are due April 30 of the following year. For a death from November 1 to December 31, the final return is due 6 months after the date of death. Where a business was carried on, the filing date can be later, but payment does not change. The T3 return is due 90 days after the trust's year-end.

Late filing with a balance owing brings a penalty of 5% of the balance plus 1% for each full month late, up to 12 months, and interest accrues daily.

• Gather cost records and date-of-death values for each capital property.
• List unused net capital losses from earlier years.
• Decide, property by property, whether any spousal rollover should be elected out.
• Track estate sales and note the estate's filing due date for any s. 164(6) election.
• Confirm the plan with a lawyer or accountant before filing.

Frequently asked questions