Losses incurred during a tax year can generally be carried forward or back to another tax year and utilized to reduce taxable income in that year. The type of loss incurred determines the length of the carryover period and any other restrictions applied to this carryover. Proper utilization of loss carryovers is a useful tool to minimize income taxes payable over a long-term period.
The two most common types of losses are non-capital losses and capital losses. A non-capital loss arises from business, such as sales or services provided, or property, such as rental or investment activities. Unused losses can be carried back up to three years prior to the year incurred or carried forward up to twenty years. Losses will expire and can not be utilized after this period. Non-capital losses can be applied against any other source of income.
Capital losses may be incurred on the disposition of capital property other than depreciable property, such as shares of another company or land. Losses on the disposition of depreciable property, such as buildings or equipment, are subject to different rules and can never be claimed as capital losses. As only 50% of a capital gain is taxable based on the current inclusion rate, only 50% of capital losses are deductible. These are referred to as net capital losses. Unused net capital losses can be carried back up to three years and carried forward indefinitely but can only be applied against capital gains.
Special rules apply to farming losses. Farming may constitute a business and losses arising from this business are generally included as part of non-capital losses. For this to occur, the farming activities or a combination of farming and another activity must be your primary source of income. If it is not your primary source of income, farming losses are restricted and can only be applied against farming income. Whether farming is your primary source of income needs to be assessed on a case-by-case basis. Restricted farm losses must be tracked separately from non-capital losses. Unused losses can be carried back three years or forward twenty years to apply against farming income earned in those years.
Special rules also apply to business investment losses. A business investment loss may arise from the disposition of capital property such as shares or debt of a small business corporation. As with capital losses, only 50% of business investment losses can be claimed and is known as the allowable business investment loss. Unlike net capital losses, allowable business investment losses can be applied against any other source of income. Unused losses can be carried back up to three years and forward up to ten years and applied against any other source of income in those years. If unused at the end of this period, the loss becomes a regular net capital loss and can be carried forward indefinitely but can only be applied against capital gains.
There are many different rules that could impact the carryover period of losses or impact your ability to claim available losses. For example, stop-loss rules may prevent you from claiming losses on the disposition of property to a related party such as a spouse, child, or a company that you control. These losses can not be claimed until the property is disposed to an unrelated party. Superficial loss rules prevent you from claiming capital losses on the disposition of capital property if you repurchase the same property within thirty days before or after the disposition. Losses may also be lost at the time of an acquisition of control. These are just a few high-level examples of some rules that may impact your loss balances.
A loss carry back must be requested as part of your annual corporation income tax return. Each year, we must assess the optimal use of your available losses and request the carry back accordingly. If a carry back is not requested, the losses will automatically carry forward and will be available in future years subject to the carry forward period.
Understanding the different types of losses and the rules regarding their deductibility ensures that you can minimize your taxes over the long-run.
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