Using Capital Losses in an Estate: Carryback to the Final Return

Investments often fall in value between the date of death and the date the estate sells them. That can feel doubly unfair: the deceased may have paid tax on a deemed gain at death, and now the estate is selling for less than the value used on the final return.

The Income Tax Act has a rule that can help in some cases. It lets the estate's legal representative ask that part of the estate's capital losses be treated as the deceased's own losses on the final return. This article explains the idea in plain terms, the conditions, and the limits. The rules are technical, so an accountant or lawyer should confirm how they apply to your estate.

Why the loss can arise in the first place

Immediately before death, the deceased is treated as having sold each capital property at its fair market value. Tax on any resulting gain is reported on the final return. If the property passes to a Canadian-resident spouse or common-law partner, or to a qualifying spousal trust, it is generally treated as disposed of at its adjusted cost base instead, subject to conditions, and the representative can elect out of that treatment.

When the estate later sells that property, the gain is reported on line 1 of the estate's T3 return. It is generally the sale price minus the fair market value reported on the final return, plus disposition costs, worked out on T3 Schedule 1. If the sale price is lower than the value used at death, the result is a capital loss in the estate, not a gain.

What the carryback election does

Where the legal representative of a graduated rate estate sells capital property at a loss in a taxation year within the estate's first three taxation years, the representative can elect to treat part of those capital losses as the deceased's capital losses in the final taxation year. The election is made in the prescribed form by the estate's filing-due date, and the representative must amend the final return.

There is a limit on where the amounts can go. They cannot be deducted for any year before the deceased's last year. In other words, the election reaches back to the final return only, not to earlier years.

Why would this help? On a final return, net capital losses, including those carried from the year before death, can reduce income other than capital gains, which is not the case in other years. That can make a loss more useful on the final return than it would be inside the estate. Capital losses on personal-use property generally cannot be claimed.

Who can use it: the graduated rate estate

The election is tied to a graduated rate estate, often called a GRE. To qualify, the estate must arise on and because of the death, be a testamentary trust, include the deceased's social insurance number on its returns, designate itself as the GRE in its first return ending after 2015, and be the only estate so designated. It qualifies for no more than 36 months after death.

Timing traps to watch

Timing is where this goes wrong most often. The first T3 for a graduated rate estate can have a tax year-end set at any date up to one year after death, and the T3 is due 90 days after that year-end. Because the election is due by the estate's filing-due date, the year-end you choose affects how long you have.

The final return has its own deadline. If death occurred between January 1 and October 31, it is generally due April 30 of the next year, and if death was between November 1 and December 31, six months after death. A later date of June 15 applies if the deceased or their spouse was self-employed and death was between January 1 and December 15. If a balance is owing and the return is late, there is a 5% penalty plus 1% per full month (up to 12 months) and compound daily interest. An amended final return can change the amount owing, so ask your accountant how interest and refunds will work.

Also be careful about the "three taxation years" wording. The statute refers to dispositions within the estate's first three taxation years, but government guidance on this point has not always been described the same way. Have an accountant confirm the version of the rule that applies to the date of death and the date of sale.

Practical points before you sell

• Keep records of the fair market value on the date of death for each investment; the final return and the T3 both rely on it.
• Do not assume the loss can be carried back automatically. It requires a deliberate election in the prescribed form.
• Confirm the estate really is a graduated rate estate and is still within its 36 months.
• Remember that the deceased's home is a separate topic: the representative still designates it as a principal residence on the final return using Form T1255 and Schedule 3, and that designation covers only years up to the date of death.

What to do next

• Gather the final return, the date-of-death values, and sale confirmations for each investment sold by the estate.
• Confirm with an accountant whether the estate is a graduated rate estate and which tax year-end was chosen.
• List each sale and calculate the gain or loss the way the T3 does, using sale price, date-of-death value and costs of sale.
• Diarize the election deadline and the filing-due date for the estate's year.
• Before distributing the estate, ask about a CRA clearance certificate, since distributing first can leave the representative personally liable for unpaid tax up to the value distributed.

If the numbers are large, or the family disagrees about timing, speak with an accountant and an estate lawyer before selling or distributing.

Frequently asked questions