Capital Losses And Non-Capital Losses: What’s The Difference?

Whether you’re an individual or own an incorporated company, you may incur a capital loss or non-capital loss on your personal or corporate tax return at some point. You may wonder what these losses are, how they affect you or your company, and where to find them. This article will answer your questions so you will know how to use them if you ever encounter them.

What Is A Capital Loss?

A capital loss occurs when the proceeds from the sale of a capital asset are less than its adjusted cost base (ACB). In simpler terms, it’s the financial loss you incur when you sell an asset for less than what you paid.

Capital assets include stocks, bonds, real estate properties, and other investments.

The ACB is the asset’s original cost plus any additional costs associated with acquiring it (like commissions or legal fees). It’s essential to calculate the ACB accurately, as it determines the actual cost of your asset and, therefore, the size of your capital loss or gain.

Imagine you purchased a stock for $10,000 (this becomes its ACB). And in 2023, due to market fluctuations, you decide to sell the stock, but you only receive $8,000. The difference of $2,000 ($10,000 – $8,000) is your capital loss.

How A Capital Loss Is Used

Any capital losses incurred in the current year must first be applied against any capital gains in the current year before any capital losses can be carried back or carried forward. The capital loss that remains is called the net capital loss.

Capital losses can only offset capital gains, not other types of income. This distinction ensures that you don’t use investment losses to reduce taxes on regular income.

Carrying Back A Capital Loss

If you don’t have any capital gains in the current year, or if your capital losses exceed your capital gains, you can carry back the excess loss to any of the three preceding tax years. This is particularly beneficial if:

• You had significant capital gains in one of the previous three years.
• You paid a considerable amount of tax on those gains.

By amending your tax return for the year(s) in question, you can get a refund for the tax you paid on the now-offset gains.

If we take the $2,000 capital loss from the example above, we could carry back that loss to 2022, 2021, or 2020 if there were capital gains reported on your tax return in any of those years.

To carry back a capital loss on a personal tax return (T1), the T1A-Request for Loss Carryback form must be completed and filed with the Canada Revenue Agency (CRA). To carry back a capital loss on a corporate tax return (T2), you must complete Schedule 4-Corporation Loss Continuity and Application and filed with the CRA.

Carrying Forward A Capital Loss

If you choose not to carry back your capital losses, or if there’s still an excess after doing so, you can carry forward these losses indefinitely. This means that if you incur a capital loss this year but don’t have any capital gains until five years later, you can still use the loss at that time.

Exception: In the year of death, net capital losses can be used to reduce other types of income in the current year or the year immediately preceding the year of death.

Superficial Losses

The superficial loss rule applies when you sell an asset at a loss and repurchase it within 30 days (before or after the sale). The CRA considers this a superficial loss; you cannot claim it. This rule prevents you from selling assets to reap tax benefits and then quickly repurchasing them.

For example, if you sell a stock at a loss and then repurchase the same stock within 30 days, the loss is deemed superficial, and you cannot use it to offset capital gains.

Allowable Business Investment Loss

An allowable business investment loss (ABIL) is a loss on an investment (either by owning shares or lending money) in a small business corporation (SBC) that earns active business income in Canada. The amount of the ABIL that can be claimed is 50% of the business investment loss.

For example, if you had a $20,000 investment in a SBC that went bankrupt, you would have a business investment loss of $20,000 ($20,000 – $0) and an ABIL of $10,000 ($20,000 x 50%).

Unlike a regular capital loss, an ABIL is not limited to reducing only capital gains; it can be used to reduce or eliminate other types of income, too.

If there are no other types of income in the current year, the ABIL can be carried back 3 years or forward 10 years and used against other types of income in those years.

If the ABIL still hasn’t been used within 10 years, it is converted to a regular capital loss. It can be carried forward indefinitely but can only be used to reduce or eliminate capital gains in future years.

It’s important to keep all documentation regarding ABILs as the CRA routinely investigates these transactions to ensure they are valid.

What Is A Non-Capital Loss?

A non-capital loss typically occurs when the total expenses of a business or property exceed its total income for the year. In essence, it represents the operational losses of a business or property.

Examples of Non-Capital Losses:

• A startup company incurs more expenses (like salaries, rent, and marketing costs) than its revenue during its initial years.
• A rental property owner spends more on property maintenance, mortgage interest, and other related expenses than the rental income generated.

How A Non-Capital Loss Is Used

Unlike capital losses, which are used to offset capital gains, non-capital losses can be applied against other types of income. If your business incurs a non-capital loss in a particular year, you can use this loss to reduce other income sources, such as employment or interest income, potentially lowering your overall tax liability.

Carrying Back A Non-Capital Loss

If your business incurs a non-capital loss in a given year, this loss can be carried back to offset income from the previous three tax years. This can result in a tax refund for those years, providing immediate cash flow relief. Like our capital loss example, a non-capital loss from 2023 could be carried back to 2022, 2021, or 2020.

To carry back a non-capital loss on a T1, a T1A-Request for Loss Carryback form must be completed and submitted to the CRA. To carry back a non-capital loss on a T2, Schedule 4-Corporation Loss Continuity and Application need to be filed with the CRA.

Carrying Forward A Non-Capital Loss

If there’s no income to offset in the current or previous years, or if there’s still an excess loss after doing so, non-capital losses can be carried forward. Non-capital losses can be carried forward for up to 20 years.

Keeping Track Of Your Losses

If you have either net capital losses or non-capital losses, it’s essential to keep track of them so they can be used in a future year where they can save you tax. Both net capital loss and non-capital loss balances can be found in your CRA My Account or My Business Account.

You can also find your net capital and non-capital loss balances on your most recent Notice of Assessment (NOA) for your personal or corporate income taxes.

Conclusion

Capital losses occur from selling assets like stocks at a loss. In contrast, non-capital losses arise from business or property losses. Capital losses can only reduce capital gains, but non-capital losses can offset various income types. You can carry these losses backward or forward to manage their tax liabilities. However, it’s essential to understand specific rules, like the superficial loss rule, to avoid missteps. Properly tracking and applying these losses can lead to tax savings, so consulting with tax experts is advisable. Feel free to contact us if you have any questions about capital losses or non-capital losses.

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