Understanding Terminal Losses

Excerpted from EverGreen Explanatory Notes

As the tax year draws to a close it’s important to understand what happens when a depreciable asset is disposed of.  If that is less than the undepreciated capital cost, a terminal loss results.  A technical tax update may be in order because some of the rules are quite interesting.

Definition.  This deduction represents the amount by which the depreciation of the value of the assets in the class exceed the capital cost allowance claimed in respect of those assets.

Calculation.   Under the Income Tax Act, S. 20(16) a deduction from business income for terminal loss is required for the amount the Undepreciated Capital Cost (UCC) of a class where, at the end of the year, the taxpayer owns no assets which belong to that class.

It is important to note that unlike CCA claims, which are optional, the terminal loss deduction is mandatory.  Here’s an example:

Issue: The corporate taxpayer operated a small trucking business for a number of years. In the current year, the corporation ceased operations and closed the business. The corporation had purchased the truck for $15,000 and had claimed Capital Cost Allowance on it. At the time of closure of the business, the UCC of the class was $6,700. However, the corporation was only able to get $5,000 for it. What are the tax consequences?

Answer: On the tax return for that year, the corporation must claim a deduction for $1,700 ($6,700 - $5,000) as a terminal loss on the truck. Over the years, the truck had decreased in value by $10,000 but the corporation had only claimed $8,300 in CCA. The terminal loss brings the deductions from income in line with the decrease in value.

Exceptions.  There are several to take note of:

• Class 10.1 assets (Passenger Vehicles) are not eligible for the terminal loss provisions. That is, each Class 10.1 asset is in a separate class 10.1 and, in the year of disposition is eligible for one-half of the normal CCA claim.
• The Act also ensures that a terminal loss is not allowed on the transfer of depreciable property in non-arm's length transactions.
• When a taxpayer disposes of a building, the proceeds of disposition are not allocated in such a way that the taxpayer claims a terminal loss on the building and a capital gain on the land.

Closing of Business

If a taxpayer ceases to carry on a business, no claim for a terminal loss is allowed for the depreciable property that was used in the business unless and until all the assets in a class are disposed of.

This would be the case where the taxpayer retains the property without using it for any other purpose. Neither may the taxpayer claim CCA on the property in any subsequent year unless it is used in that year to earn income from a business or property. If the taxpayer commences to use the property for a non-income-producing purpose, there is a deemed disposition of the property at that time at its fair market value. Such a deemed disposition could result in a CCA recapture or a terminal loss.