Most individuals and small businesses will inevitably face a financial loss at some point.
The term “loss” can refer to a variety of different situations for taxes in Canada. The type of loss would determine the impact on your personal and corporate income tax return.
The different types of losses include capital loss and non-capital loss. In this article, we’ll take an in-depth look at the differences between these two types of losses, their application, and how to carry forward or carry back losses to reduce your tax burden.
What is a Capital Loss?
If you purchase a capital property and later sell it at a lower price than what you originally paid for, you will have a capital loss. Capital properties generally include assets such as real estate, stocks, bonds, and other types of securities.
For example, if you bought 500 shares of ABC company in 2020 for $8.00 per share and sold the shares in 2023 for $6.00 per share, you have a capital loss of $1,000 plus expenses related to trading fees.
Total capital losses incurred in a year is also referred to as net capital losses, resulting from an allowable capital loss in excess of taxable capital gains.
How to Use Capital Loss
Capital loss can be applied against taxable capital gains only, and it cannot be applied to other sources of income. For example, if you incurred a capital loss of $2,000 and are working as a full-time employee, you cannot use the loss to reduce your employment income.
Although capital loss is limited to offset capital gains only, you can carry back or carry forward the net capital losses to reduce your taxes.
How to Carryback Capital Loss
Under the Income Tax Act, you can carry back the net capital losses and apply them to any of the previous three years’ tax returns.
To illustrate, if you incurred a capital loss of $2,000 in 2023 and had a $3,000 taxable capital gain reported on your tax return in 2021, you can carry back the $2,000 capital losses in 2023 and apply it against the taxable capital gains of $3,000 in 2021. However, if the taxable capital gain was reported in 2019 and you did not have any in 2020, 2021, or 2022, you would not be able to carry back the capital losses.
For personal tax, capital loss carryback can be requested by filing the form T1A Request for Loss Carryback with the Canada Revenue Agency (CRA). For corporate tax, you must submit Schedule 4 – Corporation Loss Continuity and Application with the CRA.
How to Carryforward Capital Loss
Based on the current tax rules, net capital losses can be carried forward indefinitely and applied against future capital gains.
For example, if you incurred a capital loss of $2,000 in 2023 and are unable to carry back the losses to a previous year, retain the net capital losses on record so that it can be used in a future tax year when you have taxable capital gains.
It is important to note that if you have an unused net capital loss from a previous tax year and are applying it against a capital gain in the current year, you may need to adjust the net capital loss because the inclusion rate may be different.
For example, if you had unused net capital losses of $4,000 in 1998 and want to apply it against a $5,000 capital gains in 2023, the net capital loss should be adjusted using the adjustment factor.
The adjustment factor is the inclusion rate of the year the loss is applied divided by the inclusion rate of the year in which the loss occurred.
In this example, the adjustment factor is 2023 inclusion rate (i.e. 50%) divided by the 1998 inclusion rate (i.e. 75%)
The adjusted net capital losses of $4,000 x (50%/75%) = $2,666.67 from 1998 can then be applied against the $5,000 capital gains in 2023 to reduce your tax liability.
What is a Non-Capital Loss?
As the name suggests, non-capital loss refers to all types of losses other than a capital loss. These losses may arise from various sources, such as rental property activities, sole proprietorship business activities, and more. Here are two examples of non-capital loss:
- If you have a residential rental property and the rental expenses exceed the total rental income earned for the year, you have a net rental loss. Since net rental loss is not considered a capital loss, it falls under the category of non-capital loss.
- If you are operating a sole proprietor small business and the total business income is less than the expenses incurred for the year, your business is in a financial loss position. A net business loss is considered a non-capital loss because it is not created from a capital loss.
How to Use Non-Capital Loss
In contrast to capital loss, non-capital losses can be applied against all sources of income. For example, if your rental property resulted in a non-capital loss of $3,000 and you are a full-time employee, you can use the non-capital loss to offset your employment income.
Similarly, if you received dividends from your stock portfolio or interest income from Guaranteed Investment Certificates (GIC), you can apply the non-capital loss to reduce your taxable income.
In addition to the flexibility to apply losses against different types of income, you can also carryback or carry forward non-capital losses to reduce your taxes.
How to Carryback Non-Capital Loss
Like capital loss, you can carry back non-capital losses and apply them to any of the three previous years’ tax returns.
To illustrate, if you incurred a non-capital loss of $3,000 in 2023 and reported a net income of $4,000 in 2021, you can carry back the $3,000 non-capital losses in 2023 and apply it against the net income of $4,000 in 2021. However, if the taxable income was reported in 2019 and you did not have any taxable income in 2020, 2021, or 2022, you cannot carry back the non-capital losses.
For personal tax, non-capital loss carryback can be requested by filing the form T1A Request for Loss Carryback with the CRA. For corporate tax, Schedule 4 – Corporation Loss Continuity and Application should be filed with the corporate tax return.
How to Carryforward Non-Capital Loss
According to the Income Tax Act, non-capital losses can be carryforward for 20 years and apply against future taxable income.
To illustrate, if you incurred a non-capital loss of $3,000 in 2023 and you are unable to carryback the losses to a previous year, retain the non-capital loss on record so that it can be used in a future tax year when you have taxable income. The non-capital loss carry forward in this scenario will expire in 2043.
If you have net capital losses or non-capital losses and cannot apply the losses in the current year or to one of the three previous years, ensure you are keeping track of loss balances. Net capital loss and non-capital loss carried forward balances can be verified on the Notice of Assessment or accessed via My Account for personal tax and My Business Account for the corporation.
Net capital losses and non-capital losses are subject to their own set of rules under the Income Tax Act. A thorough understanding of the differences and the ability to optimize losses can significantly reduce taxes owed on your personal tax return and corporate tax return. If you have questions about loss utilization and how it impacts your taxes, contact our team for a consultation.