When Is A Loss Not A Loss?

We all hate to lose money on a purchase or investment. Sometimes a little tax relief can help ease the pain if you can deduct the loss against capital gains you've realized, but often that very real loss is a ‘nothing’ for tax purposes.

One type of property that doesn't give rise to a tax loss is what's called ‘personal use property.’ If you bought a personal use vacation property, for example, and sold it at a loss, you wouldn't be able to deduct the capital loss against other capital gains. If, on the other hand, you sold it for a gain, that would be taxable. There are special rules to deal with small items where the purchase price and the cost of the property are less than $1,000. Generally speaking, sales of low value personal items don't result in taxable events.

What if you lend money to someone and they don't repay you? Can you deduct that loss? Maybe, maybe not. If you don’t charge interest on the loan and therefore you have no income-earning purpose, the loss would be considered a nothing for tax. What if you sell some personal property and agree to have the purchaser pay you over time? If they don’t repay the loan, that loss is more than likely not deductible as well.

In the Tax Court of Canada case Elliott v The Queen (2005 TCC 135), the taxpayer found herself in a situation where she lent a family company (in which she had no direct interest) a total of $94,000. This amount was lost when the company shut down and could not repay her. In deciding against her, the judge made the following comments:

Ms. Elliott's problem is not unusual, unfortunately. There are many people who lend money and guarantee loans to small businesses to corporations in which their spouses own shares but they do not. Many of these people are not sophisticated in tax matters. They do what they feel is important for the economic well-being of the family. They do not consult lawyers or accountants who may advise how to structure the loan or guarantee so, if something goes wrong, then, for tax purposes, they could deduct at least a portion of the money they may lose. Many of these people and their spouses are hard-working people of modest means. They do what they think is right; they are optimistic. They do not foresee possible failure. When failure does come, they lose everything....Our senior courts have told us there is no equity in a taxing statute and as the Act is written, there is not much I can do to help Ms. Elliott.

As this case demonstrates, there can be some harsh traps when dealing with losses that arise from personal items or non-income producing items. But what if you're dealing with your investment portfolio and you sell some stocks at a loss? Surely you can deduct those losses against capital gains, right?

Well, not necessarily. Let's say your investment advisor sees an opportunity to sell 100 shares of a company that has lost value and use that loss to offset gains you've had on other shares. That sounds like a good idea. But if your investment advisor (or your spouse's separate advisor) thinks that this cheap stock would be a good one to hold onto in your spouse's portfolio and acquires that same 100 shares within 30 days of your sale, your loss is denied until your spouse sells those shares.

Another situation that can arise is if you hold the same stock in more than one investment account. Your investment advisor may want to sell a stock that has gone down in value, but if you hold that same stock elsewhere and you bought that stock in the other account at a low price, you may actually have a gain because your total cost of the stock has to be averaged over all of that particular stock you own (regardless of the account in which it is sitting).

As I’ve shown here, it's very important to ensure that not only is the loss a valid one for tax purposes, but that nothing is going to prevent you from claiming a valid one.