When a client dies, any property he owned is automatically deemed sold at fair market value, which could lead to capital gains or losses. But what if that property includes stock certificates from companies that no longer exist?
If the securities are found at death
It’s usually up to the personal representative (an estate trustee in Ontario, a liquidator in Quebec) to deal with these worthless securities. If the shares are valued at $0, upon death they’re deemed to have been disposed for $0. Usually that gets the estate a capital loss.
That loss can offset any income in the year of death, or 50% of any capital gains in the previous year’s return—and sometimes both. Suddenly, the worthless shares have become valuable, especially if the adjusted cost base was high.
Assume your client bought $50,000 worth of stock, but the company went out of business five years ago. The stock certificates are found in his safety deposit box, and it turns out they’re worth $0. The capital loss is $50,000, of which $25,000 can be applied to offset income or gain.
Say his income the year he died was $15,000, and capital gains income the previous year was $10,000. The capital loss of $25,000 offsets the $15,000 income and $5,000 of last year’s capital gains. (The remaining $5,000 loss can’t be used.)
If you find securities while the client’s alive
On the other hand, a taxpayer might hold worthless shares that can’t be traded because the issuing company is insolvent, going through bankruptcy, or closing up shop.
There’s still a way out. If a client owns those shares at the end of the calendar year, she can elect to dispose them for $0 on December 31 by attaching a signed letter with her tax return to notify the CRA that she’s making this “phantom transaction.”
Then, on January 1, she’ll immediately re-acquire the same shares for $0, also by attaching a letter to that year’s tax return. That lets her claim a capital loss for the original purchase price.
But if she didn’t use the allowable capital loss and died the next year, the losses can be carried forward to offset income or gains in that year.
Our example assumes the shares are of a publicly traded company. If these were shares of a qualified small business corporation, and a loss was realized under similar circumstances, the taxpayer could use an Allowable Business Investment Loss (ABIL). That loss can then be applied against gains and other types of income.
Caveat for living and dead shareholders
The election to dispose of worthless shares may not be available to shareholders of companies under cease-and-desist orders, or if the taxpayer received shares in exchange for disposing of personal property.
Also, if the client sells the shares after they appreciate in value from $0, gains will be realized and must be reported as the adjusted cost base would be nil. For instance, assume your client buys shares at $100. They drop to $0, and he uses the election to claim losses. If he still holds the shares and they appreciate to $20, his capital gain is now $20 because his adjusted cost base, after the election, was $0.