Published: February 3, 2022
Introduction – Deemed Disposition Upon Death and Double Taxation
One of the major considerations in estate planning for Canadian taxpayer is the deemed disposition upon death. Under paragraph 70(5)(a) of the Income Tax Act, when an individual dies, all owned capital property is deemed to have been sold immediately prior to death for proceeds equal to the fair market value of the property.
However, since no property is actually sold when the Income Tax Act deems there to be a disposition upon death, double taxation can occur since the fair market value of the properties are taxed once with deemed disposition upon death, and again when the estate actually disposes the property. This double taxation can be occur when the estate realizes a capital loss after the property of the deceased is deemed to be transferred to the estate upon death. The estate, as a separate person under the law, cannot offset any previously incurred capital gains of the deceased with the capital loss. A tax planning method to avoid this problem is for the testator to have already vested his or her capital properties in a corporation via estate freeze. These properties will not be subject to deemed disposition upon death, and any capital losses incurred by the holding corporation can be used to offset previous incurred capital gains.
Subsection 164(6) of the Income Tax Act is aimed to provide relief against potential double taxation.
This article will explain the subsection 164(6) loss carryback rule and how it interacts with other rules under the Income Tax Act.
Subsection 164(6) – General Outline
A graduated rate estate is the estate that arose on and as a consequence of the individual’s death.
Subsection 164(6) of the Income Tax Act provides for a mechanism where a graduated rate estate has the option to elect under subsection 164(6) to carry a capital loss from the first year after death of the testator back against the capital gains incurred in the terminal year of the death of the testator. This loss carryback provision can only be applied for the capital gains in the terminal year of the deceased and cannot be applied for capital incurred in any prior years to the terminal year.
For the subsection 164(6) election to apply, the estate of the deceased must dispose of the capital property of the estate or all of the depreciable property of a prescribed class of the estate within the first taxation year of the estate. We will further discuss the timing issue at the section below.
Subsection 164(6) – Timing Issue
A tax year-end may or may not coincide with a calendar year end of December 31 depending on the type of taxpayer and the elections made by the taxpayer. Under the Income Tax Act, individuals always have a tax year between January 1 to December 31.
However, a gradual rate estate can designate its tax year end flexibly outside of the December 31 year end. This means a graduated estate maybe enjoy the opportunity to “lock-in” their loss carrybacks before the December 31 year end. Consult our experienced Toronto tax lawyers to make sure this is done correctly so as to minimize the overall estate taxes.
Subsection 164(6) – Graduated Rate Estate Status
The estate of the deceased must qualify for the graduated rate estate status in order to make the subsection 164(6) election. There are four requirements it must meet to be considered a graduated rate estate:
- must be a testamentary trust resident in Canada,
- it must designate itself as such in the T3 return of its first taxation year,
- it must be the only graduated rate estate for that testator, and
- graduated rate estate can only exist no longer than 36 months after its formation.
Subsection 164(6) – Shares in an Affiliated Corporation
When the capital property disposed under a subsection 164(6) election are shares in a corporation, it is important to pay attention to the stop-loss rules in subsection 40(3.6) and the relief rule in subsection 40(3.61)
Subsections 40(3.6) prevents taxpayers from deducting losses arising from disposition of shares in an affiliated corporation that is affiliated with the taxpayer immediately after the disposition. It does so by deeming the loss to be nil when the taxpayer and the corporation are affiliated persons immediately following the disposition. This rule is designed to prevent taxpayers from artificially generating losses for tax purposes through disposing a property to an affiliated person while effectively still controlling the property.
Subsection 40(3.61) was specifically introduced to restrict the application of 40(3.6) in estate context. When a graduated rate estate elects to use subsection 164(6) loss carryback rule, any application of the subsection 40(3.6) stop loss rule will only be restricted to loss only to the extent that the amount of the loss exceeds the portion of the loss to which the election applies. This makes subsection 40(3.61) a relief provision to override the operation of the stop-loss rule where capital loss is carried back by a graduated rate estate under subsection 164(6).
This means even when the estate and the corporation remain affiliated persons after the estate made its disposition for a capital loss under its subsection 164(6) election, the estate can nevertheless carryback that capital loss against the terminal year capital gain of the deceased without having subsection 40(3.6) deeming such loss to be nil.
Pro Tax Tip – Plan for Your Estate Before Post-Mortem Tax Planning
While a graduated rate estate structure can enable the estate to avoid double taxation as well as enjoy flexible tax year-end elections, capital gain upon death can be more effectively deferred and mitigated with estate planning when making a will. With the advice of experienced Canadian tax lawyers, estate planning structures such as section 85 or section 86 estate freeze, pipeline structure with related corporations and family trust can all be effectively used to achieve your tax planning goals. Whatever your tax planning goals, our experienced Toronto tax planning lawyers are always available to help.
Disclaimer:
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."
About the Author
FAQs
Unfortunately, the CRA has no discretion to extend the deadline for subsection 164(6) election. If the estate missed the deadline, then no subsection 164(6) election can be made.
Whether cryptocurrency is considered a capital property under the Income Tax Act has to be decided on a case-by-case basis. It is certainly possible for cryptocurrency be considered capital property and be subject to deemed disposition upon death
Under paragraphs 111(1)(a) and (b) of the Income Tax Act, a non-capital loss can be carried back three years and forward seven years. A net capital loss can be carried back three years and forward indefinitely. Whereas subsection 164(6) loss carryback can only be carried back one year in the following manner:
- the estate trustee must identify the deadline to file the T3 return for the estate
- the estate trustee disposes the decease’s capital property for a lot before or on the deadline
- the trustee must designate the trust as a graduated rate estate on the T3 return and report the capital gains and losses for disposition o capital property in Schedule 1 T3SCH1 Dispositions of Capital Property
- The CRA requires the trustee to then attach the following information:
- a letter indicating that you are making an election under 164(6) and providing all of the following information:
- the amount of the capital loss you elect to be a capital loss of the deceased person
- the amount of the terminal loss you elect to be deductible in computing the income of the deceased person
- a schedule with details of the capital loss
- a letter indicating that you are making an election under 164(6) and providing all of the following information:
a schedule with the details of the terminal loss and a statement of the amounts that would have been the non-capital loss and the farm loss of the estate for its first tax year had the election not been made
A carryback is applying a loss sustained or a portion of a credit not used in a given period that may be deducted from taxable capital or business income in prior period.
A section 164 carryback allows the estate of a deceased taxpayer that is a graduated rate estate to carryback all capital losses upon disposition of capital property of the estate within the first year of the estate against all capital gains arising from the disposed property in the decease’s terminal tax year.
