Tax Consequences of Loans to Friends or Family
If you loan money to a friend or family member to help them buy a car or a house, or start a business, the expectation is that they’ll pay you back. But what if they don’t?
Capital Loss Election
Unless you’re in the money-lending business, your right as a creditor to receive repayment of a loan is considered a capital property. If a loan becomes uncollectible you can request the CRA to consider it disposed for nil proceeds, triggering a capital loss. You can then use that loss to offset any capital gains you earned in the same taxation year, in any of the three preceding years, or in any future year.
To preserve your ability to realize a capital loss on a loan to a friend or family member, it is critical that the loan be interest bearing. The interest rate can be nominal (0.1% for example), but you must charge interest and report the interest earned on your income tax return.
Loan to a Corporation/Business Investment Loss
If you loaned money to a friend or family member’s company and that company is a Canadian-controlled private corporation that is a “small business corporation” (where 90% or more of its assets, measured by fair market value, are used principally in an active business carried on primarily in Canada), and the loan was not repaid, the resultant capital loss would be considered a “business investment loss.” In that case, half of the business investment loss may be deducted against income from any source, not just capital gains.
The rules here require that the debtor be a small business corporation at the time election is made in respect of the loan receivable, or at any time in the 12 months before the disposition. Therefore, it is good practice to monitor the status of the debtor corporation so you don’t miss the opportunity to claim the unpaid loan as a business investment loss.
If you’re thinking about loaning a friend or family money, it would be best to speak with your DMCL advisor first. You obviously expect the loan to be paid back, but you should be prepared for the possibility that it won’t be.