The new three-year estate loss carryback: More time, more opportunity, more risk

What is subsection 164(6)?  

When an individual dies, the deceased is deemed to have disposed of their capital property at fair market value immediately before death, under the Income Tax Act. The result is a capital gain on the terminal return, and tax is often payable even though nothing has actually been sold. If the property later declines in value and is sold by the estate, the resulting loss belongs to the estate rather than the deceased.

This can create a mismatch: the deceased may have paid tax on the date-of-death value of the property, while the subsequent loss is trapped in the estate. The loss carryback strategy under subsection 164(6) is intended to address that mismatch by permitting certain losses realized by a graduated rate estate (GRE) to be carried back and applied against gains reported on the deceased's terminal return.

This election can create planning opportunities in several common estate situations. It may apply, for example, where marketable securities decline in value after death. It’s also a key tool for many business owners to help mitigate the double taxation that can arise when private company shares are taxed on death and the corporate value is later distributed to the estate. Less commonly, it may also be helpful where the deceased’s family home is part of the estate, even if the property’s value has not declined. 
 
In broad terms, a subsection 164(6) carryback election can apply to:

• Excess capital losses realized by the GRE in an eligible year
• Terminal losses on depreciable property that would otherwise create a non-capital or farm
• loss for the GRE for the year
• Certain losses involving employee stock options.

The new three-year rule

For deaths occurring after August 11, 2024, that relief under subsection 164(6) has been significantly expanded. The election now applies to eligible losses realized in the first three taxation years of the GRE, rather than only the first. While it gives executors and advisors more flexibility, there’s also a significantly longer period during which an unintended error can jeopardize access to the election. This makes certain estate administration decisions more important.  

Before this change, the former one-year period often didn’t reflect the realities of estate administration, resulting in estates losing valuable tax relief because necessary steps couldn’t be completed in time. Probate delays, market conditions, creditor claims, difficulties gathering information, estate disputes, and complex private company post-mortem planning can all delay the transactions needed to effectively use the loss carryback strategy under subsection 164(6).  

Private company shares on death

If an estate owns shares of private corporations, a subsection 164(6) election can be used to address the double taxation that could arise.

Unless there’s a spousal rollover on death, the deceased is deemed to dispose of the shares immediately before death and may realize a capital gain and pay tax on the gain. Where the estate's shares are later redeemed, the redemption proceeds are generally treated as a dividend rather than sale proceeds. Since the shares' tax cost generally reflects their fair market value at death, this may result in a capital loss to the estate. The estate may then elect under subsection 164(6) to carry that loss back and offset all or part of the capital gain reported on the deceased's terminal return. In broad terms, this strategy can eliminate the double taxation, such that the same corporate value is ultimately taxed only as a dividend received by the estate on the redemption.

For estates holding private company shares, the new three-year election period provides greater flexibility to complete valuations, review shareholder agreements, consider capital dividend account (CDA) and refundable dividend tax on hand (RDTOH) implications, coordinate insurance proceeds, and implement a post-mortem plan. Under the former one-year regime, these planning steps often couldn’t be completed before the loss carry back opportunity expired. 

However, the new rules don’t eliminate the need to sequence transactions carefully. Capital gains realized by the GRE in the same taxation year as a redemption loss can reduce the amount of loss available for carryback. This can be particularly important where the stop-loss rules in subsections 40(3.6) and 40(3.61) apply.

The family home: an often-overlooked opportunity

The loss carryback strategy may even create planning opportunities in estates where a loss arises from selling a family home.

Assume a home is worth $1 million at death and the accrued gain is fully sheltered on the terminal return by the principal residence exemption. Two years later, the estate sells the home for $1 million but incurs real estate commissions and legal fees. 

A property that qualifies for the principal residence exemption on the deceased's terminal return can still generate a capital loss in the estate, provided the property isn’t a personal-use property of the estate. In this example, even though the value of the home has not declined, the estate may realize a capital loss equal to the selling costs incurred. That loss can be carried back under a subsection 164(6) election. Once carried back, the allowable portion becomes part of the deceased's net capital loss for the year of death. Subject to the special year-of-death rules, that loss may offset not only taxable capital gains but also other sources of income reported on the terminal return.  

The personal-use property rule

If the property becomes a personal-use property of the estate, no capital loss on the property can be recognized, which could then prevent the use of the subsection 164(6) election. Specifically, if the property is used primarily for the personal use or enjoyment of a beneficiary or a person related to a beneficiary while held by the estate, any resulting capital loss will be denied. This can happen, for example, if a beneficiary stays in the home before it’s listed for sale, or family members continue to use a cottage while probate is pending. That being said, a property that was personal-use property of the deceased doesn’t automatically remain personal-use property of the estate.  

Executors should consider this issue early where an estate asset may ultimately be sold for less than its date-of-death value, including where the loss arises solely from selling costs. 

GRE status

While the expanded rules provide executors with more time, it also increases the period during which GRE status needs to be preserved, as a subsection 164(6) election is only available to a GRE. 
One common way to accidentally lose GRE status is when a beneficiary or related person pays estate expenses (e.g., funeral costs, probate fees, accounting fees, property taxes, insurance) personally.  

The legislation provides certain exceptions. For example, the estate could still qualify as a GRE if the person is fully repaid within 12 months after making the payment. However, an often-overlooked condition is that where the payment itself was made more than 12 months after death, the exception may only be available where it’s reasonable to conclude that an arm's length person would have made the same payment in the same circumstances.  

A family member may be willing to pay an expense on behalf of the estate, without interest, security, documentation, or a fixed repayment date. An arm's length person likely would not. As a result, what appears to be a convenient payment arrangement can create a technical risk to GRE status. To get around this 12-month rule, the legal representative of the estate could apply to the CRA for an extension—but the application must be made 12 months of the death. Therefore, estate executors should review whether this extension could be helpful as early as possible.  

Watch out for arrears interest

Executors should also be careful about arrears interest. If tax is owing on the terminal return, it may still be prudent to pay it when due, even if a subsection 164(6) election is expected later. A future loss carryback may reduce the tax, but it generally will not erase arrears interests. This issue becomes more important now that the loss may not be realized until the second or third GRE taxation year.

Practical takeaways

The expanded subsection 164(6) election is a significant improvement.  It provides executors and advisors with more time to realize losses and complete post-mortem planning. However, the additional flexibility does not eliminate the need for careful estate administration.  

At the outset of estate administration, executors should discuss the following matters with their advisors, among others:

• What gains were triggered by the date-of-death deemed disposition, and what tax liability resulted?
• How will that tax liability be funded?
• If private company shares are involved, what post-mortem planning options are available?
  • What information or valuations will be required?
  • How do the corporation’s tax attributes (such as CDA and RDTOH) and underlying assets (including potential ‘bump’ opportunities) affect the choice of strategy?
• Are gains and losses being realized in a manner that maximizes the benefit of a subsection 164(6) election?
• What GRE year-end is most appropriate in the circumstances?
• What procedures should be implemented to monitor and manage estate expenses paid personally by beneficiaries or other non-arm's length persons?
• Should a request be filed with the CRA to extend the 12-month indebtedness deadlines before they expire?
• Could any estate asset be sold for less than its date-of-death value (because of market declines or selling costs)?
• If so, is there any risk that the property could become personal-use property of the estate?
• Even if a loss carryback is anticipated, should terminal tax still be paid when due to reduce arrears interest exposure?

If you are planning your estate, or acting as an executor or trustee, speak with your Doane Grant Thornton advisor about whether these new rules create planning opportunities in your particular circumstances.

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^{Disclaimer 
The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Doane Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.}