The Income Tax Act provides two elections that allow for the transfer of losses from a trust to an individual: elections under subsections 104(13.1), 104(13.2), 164(6). Let’s take a deep dive in each of them.

Election under subsection 164(6)

In the first year of a graduated rate estate (testamentary trust), the legal representative can elect to treat certain capital losses and terminal losses, arising in the first tax year of the deceased person’s graduated rate estate, as losses of the deceased person for that person’s final tax year [ITA 164(6)].

A letter must be filed indicating the following [T4013]:

·        a letter indicating that you are making an election under 164(6) and providing all of the following information:

o   the amount of the capital loss you elect to be a capital loss of the deceased person

o   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 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

The election amount is also deducted from line 1646 of Schedule 1.

In addition to the election letter, an amended final T1 return must be submitted to claim the losses after the T3 tax return has been assessed [ITA 164(6)].

Under proposed amendments( https://fin.canada.ca/drleg-apl/2024/ita-lir-0824-l-3-eng.html) , the federal government would extend the eligibility of this transfer by two years. GREs would be able to transfer losses to the final return of the deceased individuals throughout the time the testamentary trust is considered a GRE, or three years.

Election under subsections 104(13.1)/104(13.2)

In cases where all or almost all of the income gained by a trust is allocated to beneficiaries, a trust cannot utilize unused capital and non-capital losses from prior years to reduce income,  and also cannot transfer these losses to beneficiaries.

In these situations, ITA 104(13.1) (non-capital losses) & 104(13.2) (capital losses) allows for an election, by the trust, to designate an amount to reduce the income paid to beneficiaries and increase its own income in order to use up the losses from prior years. By doing so, the amounts designated by the trust under these subsections are deemed to not have been paid to beneficiaries [ITA 104(13.1) & 104(13.2)]. Therefore, the beneficiary is not required to include it in income, and the trust will not pay tax on these designated amounts because they are canceled out by the losses from the prior years. The designated amounts have been effectively transferred to the beneficiaries tax-free.

When designating an amount under ITA 104(13.1) & 104(13.2), taxable income must be reduced to zero [ITA 104(13.3)]. This measure cannot be used to artificially increase taxable income above zero.

This election is only available to trusts resident in Canada [ITA 104(13.1) & 104(13.2)].

The procedure to file an election is to indicate the designation on line 427 of the T3 tax return and include a statement showing the income you are designating and the amounts you are designating for each beneficiary.

Late submissions of this election are permitted. Filings to amend the tax position of the trust and the beneficiary are as follows [TI 2016-0634901C6]:

·       The trust would file Form T3A “Request for a Loss Carryback by a Trust” in connection with the loss year to request the loss be carried back to the prior year.

·       The trust would file Form T3-ADJ “T3 Adjustment Request” for the prior year to reflect a late subsection 104(13.1) or (13.2) designation so as to amend the trust's T3 Return.

·       The trust would issue amended T3 slips to the beneficiary for that prior year, reducing the income allocated.

·       The beneficiaries would file a Form T1-ADJ “T1 Adjustment Request” to reflect the revised T3 slip and to amend the T1 Return.

Here’s an example of how this election works with a capital loss:

New Trust has taxable capital gains of $30,000, and a capital loss carry forward of $10,000. As per the trust document, all income gained within New Trust is to be allocated to beneficiaries.  New Trust would like to apply subsection 104(13.2) to use the losses

Without the subsection 104(13.2) election, there is no way for New Trust to use the losses carried forward since all income is allocated to the beneficiaries.  

By electing under subsection 104(13.2), New Trust artificially inflates net income by the amount of the capital loss carry forward in order to use it. By doing so, the amount of loss is deemed not to have been paid to the beneficiary, and only $20,000 is declared as allocated to beneficiaries. The $10,000 is effectively transferred to the beneficiary on a tax-free basis.