The article “FP Answers: Should I hold onto my capital losses until death to leave a larger inheritance?” was originally published in Financial Post on June 7, 2024. By Julie Cazzin with Andrew Dobson.

Proposed capital gains tax hike later this month presents more complications

Q: I know that capital losses can only be applied to offset capital gains and not ordinary income, except in the year of death, when capital losses can be used to offset ordinary income. I’m 72, retired and my income is roughly $170,000 from my Canada Pension Plan (CPP), Old Age Security (OAS), Registered Retirement Income Fund (RRIF) and unregistered accounts. Would it be beneficial as a tax-saving strategy for me to hold onto my capital losses until my death to leave a larger inheritance for my two children? My RRIF is roughly $1 million and there will be a huge tax bill to pay at that time. My unregistered account has roughly $200,000 in accumulated capital gains. And are there other tax strategies to consider for my estate? — Desmond

FP Answers: Desmond, there are several strategies you can consider in your situation, given the unique treatment that capital losses can have at death. You will incur either a capital gain or loss when you sell an investment in a taxable, non-registered account. Under existing tax rules, one-half of the capital gain will be taxable, and in the case of a capital loss, you can claim one-half of it.

The impact of your decision may be further complicated by the proposed capital gains inclusion rate increase to two-thirds starting June 25. Though these new rules do not apply to individuals with less than $250,000 of realized capital gains in any given year, it is possible that if you defer the gains and your portfolio continues to grow, then a portion of your gains could be taxable at the higher rate in the year you die.

The new, higher inclusion rate is more likely to apply to individuals selling a single high-value asset such as a cottage, rental property or high-end collectible. I’ll also note that the higher inclusion rate applies to all capital gains in corporations and trusts.

Capital losses can be flexible. You must first claim a capital loss against current-year capital gains. If you have more losses than gains in a given tax year, you can either carry the loss back or carry the loss forward.

A loss can be carried back up to three years. It may make sense to carry the loss back as far as possible so that you don’t miss an opportunity to reduce a previous capital gain. But if you had significantly higher income in one of the past three years, then that may be the best year to carry the loss back to maximize a tax refund.

You can carry losses forward indefinitely since they do not expire. Losses can be used for purposes other than applying them against realized capital gains when a taxpayer dies. This includes the ability to apply them against income such as interest, dividends, pensions or RRIF income.

There are several nuances to the capital loss rules. For example, a capital loss that is realized in the first tax year by an estate cannot be applied to preceding tax years. Also, if you have capital gains on your final return, any unapplied capital losses must be applied to capital gains in order from the oldest to the latest tax year. Only then can you use the unapplied losses to offset other income in the year of death and the year before that.

Finally, and this may apply to your situation, if you have unapplied losses that can be applied to income other than capital gains, these cannot be used to offset social benefit repayments such as the OAS clawback.

In your case, Desmond, I’d be hesitant to carry forward losses to your year of death rather than claiming them along the way. You have a high income of $170,000 in a normal year, so capital gains are taxed at a minimum of 18 per cent to 24 per cent, depending on the province or territory where you live, and likely higher if you have a big capital gain to push your income even higher.

By comparison, capital losses claimed in the year of death at the highest tax rate would save between 22 per cent and 27 per cent in tax. That is not much different from your current tax rate and could be many years in the future.

Although you may end up with a particularly high tax bill in your year of death, the time value of money is the main consideration here. If you could save three per cent or four per cent more tax in 20 years than you could today, you would be better off having the refund earlier. This should help you build a larger estate in the long run, even on an after-tax basis, for your kids. And your kids will be able to use that larger estate value to pay the inevitable tax upon your passing.

Minimizing your lifetime tax is a good retirement and estate strategy, Desmond. But I think in your case, your capital losses may be better off claimed sooner rather than later.

Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at adobson@objectivecfp.com