Transfer of Investment Losses Between Spouses Using Corporate Class Funds
by Evelyn Jacks
Offsetting capital gains with capital losses of the current year or unused losses of prior years,dating all the way back to 1972,is part of the process to minimize the effect of taxes.Is it possible to do so both on an individual and inter-spousal basis? The short answer is yes, when observing some special tax rules. If your investment is in corporate class funds,taxes can be minimized even further.
Consider the following scenario: Judy holds corporate class funds that have an unrealized loss of $25,000.She acquired them for $50,000. She has no capital gains of the current or prior three years to use the losses against. Her husband, Steve, though, who is also invested in corporate class funds,has accumulated $100,000 in unrealized capital gains. Steve can offset part of his tax liability when Judy transfers her losses to him.
Here’s how this can be accomplished. (These strategies follow several important tax rules, which are defined in the sidebar,“Tax Rules for Spousal Transfers.”)
Sell the shares and trigger the loss. In the case of corporate class funds, the taxpayer (Judy,in this example)must actually exit the corporate class structure, as switches between fund classes do not trigger tax consequences.The spouse, Steve, buys back the same class of corporate class shares within 30 days for the same value,triggering the superficial loss rules (as the spouse is an “affiliated party.”) His Adjusted Cost Base (ACB) is increased by the denied loss. After
30 days from the date of the sale by the first spouse,the shares can be sold by the second spouse on the open market.At this point, the legitimate loss is created for use against other capital gains.
Transfer the funds to the spouse. It is also possible to transfer the funds to the spouse, thereby creating a deemed disposition at a loss. However,because these two parties are “affiliated,” that loss is considered to be superficial and therefore denied. When such a loss is denied, it may be added to the acquirer’s adjusted cost base. But to avoid the Attribution Rules,which attribute the loss back to the transferor, the shares must be transferred at fair market value
(FMV). There are a few steps to take before this is possible:
File an election to transfer the shares at FMV, which is allowed under Subsection 73(1) of the Income Tax Act. (Otherwise,the transfer would be done at the Adjusted Cost Base, which generally means that no gain or loss occurs on the transfer and that resulting gains or losses are later attributed back to the transferor.)
Pay for the Shares. The spouse must either buy the shares for cash or, to transfer ownership at FMV without cash payment, draw up a promissory note between the spouses and charge the Canada Revenue Agency’s prescribed rate of interest. The interest charged must be paid by the transferee within 30 days of the tax year on the promissory note, and reported by the transferor.
Provided the recipient spouse holds the shares for at least 30 days before selling them on the open market, the loss is legitimized on the subsequent sale and can be used to offset other gains of the year or the immediately preceding three years.
In the case of Judy and Steve, the calculation works this way: The ACB of Judy’s shares is $50,000, but the current value is $25,000:
Judy transfers shares to Steve, and generates an actual loss by electing out of the spousal rollover provisions using Subsection 73(1)as noted above. Her loss is denied under the superficial loss rules, as they are affiliated parties, but Steve may adjust his cost base by the denied loss.
Steve sells the shares on the open market after 30 days for $24,000. His loss is $24,000 less $50,000 or $26,000. He can now use the loss to offset his other gains of the year, thereby saving the family unit significant tax dollars.
Such a strategy works well when the spouse acquiring the loss is in a higher tax bracket than the transferring spouse and has the required capital gains against which the loss can be used to reduce taxation.
Tax Rules for Spousal Transfers
The Attribution Rules:
Capital transferred to a spouse will result in the taxation of the associated income and capital gains in the transferor’s hands. The Superficial Loss Rules: A capital loss will be denied if it is superficial; that is, it occurs during a 61 day period – 30 days prior to a sale, the day of the sale and 30 days thereafter – between affiliated parties or when “identical properties ” are purchased in that time frame by the taxpayer or an “affiliated taxpayer,” which
includes a spouse or common-law partner. The Rules on Transfers Between Spouses: This is automatically considered to be at the adjusted cost base, thereby causing a tax-free rollover, unless an election is made to transfer the property at fair market value.
More on Superficial Loss Rules and Corporate Class Funds:
To trigger a capital gain or loss,an investor in corporate class funds must redeem from the corporate class structure. However, an investor can buy back into the corporate class structure immediately and avoid the superficial loss rules as long as they do not buy back the identical class of shares.They can, however, purchase a share class that is similar to the one they just sold. The broad choice of funds within some many corporate class structures make this strategy possible. Alternatively,
an investor could switch between the corporate class and the mutual fund trust version of the same fund without being subject to the superficial loss rules.
Evelyn Jacks is the author of 30 best-selling books on the subject of personal income taxation, and the President of Knowledge Bureau, Inc., Canada’s leading professional education publisher in the tax and financial services industry, specializing in delivering courseware and information services to knowledge-based practices. For more information call toll free 1-866-953-4769 or visit www.knowledgebureau.com.
This article is written to be of a general nature and neither the author, her company, employees, subcontractors or others associated with The Knowledge Bureau can take responsibility for any results, positive or negative, taken by any persons. While the author received a fee to write this article, she is not in the business of providing advice on investment products and is not registered and licensed to do so, nor does the author have any compensatory relationship, or beneficial ownership
regarding the sale of investment products discussed herein