Next year, one Charles L. Harris gets out of prison. Thirteen years ago, the fund manager from Winnetka, Ill., was convicted of fraud when he took money from clients and used it to fund a lavish lifestyle, including several luxury cars and a home in Florida. As the authorities closed in on Mr. Harris and were about to arrest him, he made one last attempt to gain his clients’ support, asking them to give him more time to make them whole. He made this plea by sending each of his clients a DVD with a message from him, recorded from the deck of his 62-foot yacht, likely somewhere in the Caribbean.
What about you? Have you lost any money to fraudulent schemes? Or perhaps just plain bad investments? If you find yourself in this boat, there’s still time in 2018 to ensure you get some tax relief for your losses. Here’s a tax primer on “failed investments."
If you receive any income from your investment at all, you’re required to report it on your tax return. This could be interest, dividends, royalties, or some other payment. This is true whether the investment is determined later to be a scam or not. Even if, for example, it’s determined that your money was not actually invested on your behalf and the amounts paid to you came from another person’s investment in the scheme, which is often the case with a Ponzi or Ponzi-like scheme, you’ll still have to report the amount received as income. If you previously reported an amount in your income but haven’t yet received the amount, and ultimately can’t collect the amount, you should be able to claim a deduction for a bad debt.
If you made an investment – fraudulent or not – and you’ve lost all or some of your money, you may be able to claim a loss on your tax return. The question to ask is: Will this be a capital loss, or a business loss? Capital losses are generally limited to being applied against capital gains to save you tax. Business losses, on the other hand, can be applied against any source of income to reduce your taxes owing.
The facts will dictate the proper treatment. Check out my article dated Jan. 14, 2015, on The Globe and Mail’s website, or Interpretation Bulletin IT-479R (paragraphs nine to 13) on Canada Revenue Agency’s website for more on this.
It’s far more common for capital loss treatment to apply. If this is the case for you, there may be some additional relief if you’ve invested in the shares of, or loaned money to, a small business corporation (a small private company). This type of loss may qualify as an “allowable business investment loss” (ABIL), which is different than a usual capital loss in that it can be deducted against all sources of income – not just taxable capital gains. You generally have 10 years to claim an ABIL against other income, otherwise it will turn into a normal capital loss after that time. Normal capital losses can be carried forward indefinitely until they’re applied against capital gains, or they can be carried back up to three years to offset capital gains in the past. There are specific tests to meet for a loss to qualify as an ABIL – so talk to a tax pro about it.
If you’ve loaned money at interest and that amount has become uncollectible in the year, our tax law will generally allow you to recognize a capital loss for the amount of the uncollectible debt. If you make the proper election on your tax return (speak to an experienced tax pro about how this is done), you’ll be deemed to have realized that capital loss.
What happens if you unexpectedly recover the amounts that you thought you had lost forever? Well, if you had previously claimed a business loss, you’ll need to report the recovered amount as business income. If you claimed a capital loss for the amount, you’ll have to report the recovered amount as a capital gain in the year you receive the amount.
Interest and carrying charges are deductible if you incurred those costs with the intention of earning income from the investment. If you’ve incurred these costs related to a failed investment, but you didn’t claim the costs in the past, you should file an adjustment request using Form T1-ADJ (one form for each tax year). Even if the investment you’ve made has become worthless, any interest on money borrowed to make that investment will continue to be deductible (this deduction will end to the extent you recover your money and fail to keep those dollars invested to earn income in some way).
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at firstname.lastname@example.org.