Taxes on assets still apply after death
Today’s column is designed to provide you with an understanding of the tax implications of holding various non-registered assets and registered assets (RSP’s, RRIF’s, etc.) when you pass away.
Unlike other countries, Canada does not have a death, estate or inheritance tax when a person passes away. Instead, Canada imposes a “deemed disposition” on the date of death. This means that you are deemed to have sold of all your capital property for fair market value immediately prior to your death. This includes everything from your home, car, vacation properties, business assets, personal effects, investments, art, jewelry and more. The result is that if any of these assets have appreciated in value since you acquired them, there will be a ‘capital gain’ (the difference between the original fair market purchase price of an item and the fair market value of the same item today).
If the value has appreciated, taxes will be owing on the capital gain in the year of death. Therefore, depending on the type of property you own at death — and depending upon the tax-smart planning implemented by you prior to death, this could leave your estate with a hefty tax liability.
The most common exception to the deemed disposition rule is when capital property is transferred to the deceased taxpayer’s spouse/partner. This inter-spousal transfer occurs at the deceased taxpayer’s adjusted cost base (ACB) in the property, not its fair market value, and therefore no tax liability will result by leaving assets to your spouse/partner on death. (ACB equals the fair market value of the item when originally acquired, plus any additional costs in restoring or improving it.) There are other exceptions including spousal/partner trust, which I will not delve into in today’s column.
In order to calculate the capital gain on death, the ACB of the asset is subtracted from the proceeds of disposition. The proceeds of disposition equal the fair market value of the asset immediately prior to death. For some assets such as mutual funds or publicity traded shares, this value is quite easily attainable. For other assets such as real estate, private company shares or business assets where the fair market value is not readily available, an appraiser may be required to help determine the fair market value.
The ACB, in a simple world, would be the amount that you paid for an asset. However, there may be other factors that increase (or decrease) the ACB. It is important to know if the ACB has been altered, as a higher ACB means that a taxpayer would have a lower capital gain and hence, a lower tax liability. Once the capital gain is calculated, the taxable portion must be included on the deceased taxpayer’s final tax return. With a capital gain inclusion rate of 50 per cent, only 50 per cent of the capital gain must be reported on the final tax return. This may nonetheless amount to a considerable liability for the estate. Be sure to speak with a qualified tax advisor to ensure your understanding and calculations are correct.
There are certain properties for which the deemed disposition on death may not result in any tax liability. This is due to certain exemptions that are available. More specifically, the principal residence exemption and the exemption on qualified small business corporation shares (QSBC) or qualified farm property. This exemption is commonly referred to as the lifetime Capital Gains Exemption (CGE), which is currently set at $750,000. This means that the first $750,000 in capital gains realized from the sale of shares in a qualified Canadian-controlled private corporation would not be subject to capital gains taxation.
Most people understand the personal residence exemption, however It may be prudent to speak to a qualified tax advisor if you hold shares of a small business corporation or farm property. As death can be untimely, it is critical to ensure that your shares remain qualified for the purposes of the exemption to avoid any unwanted tax at the time of an unexpected death.
Also, with regard to the personal residence exemption, for those whom have cottages, or summer homes, that have considerable capital gains issues, you should speak with your accountant about the wisdom of designating your cottage, as opposed to your city home as your principal residence. Thousands of dollars in tax may be saved.
The tax treatment with respect to “registered” plans is much different than that of non-registered capital property, discussed above. The following illustrates how an RRSP/RRIF is treated for tax purposes in the year of death:
1. The taxpayer is deemed to have received, immediately prior to death, the full fair market value of your plan assets. This amount is included in income on a deceased taxpayer’s terminal return.
2. If an RRSP or RRIF is left to an “eligible person” (an “eligible person” includes your spouse or common-law partner, a minor child, or a financially dependent infirm child or grandchild), then the eligible person receives these assets as a “refund of premiums”. In this case, the deceased receives a deduction for the amount left to the eligible person. This deduction will offset the RRSP/RRIF income inclusion at the time of death (as noted in step 1). The result is that the deceased has no tax liability on the RRSP/RRIF assets.
3. The eligible person receiving the refund of premiums will now be taxed on the premiums received unless proper steps are taken to defer the tax (see step 4).
4. If the eligible person transfers the plan assets received as a refund of premium to his/her own RRSP, RRIF or annuity (in the case of a minor), he or she will be entitled to a deduction for the amount transferred. The result is that tax is deferred until the eligible person makes withdrawals from his or her own RRSP, RRIF or annuity.
Another investment vehicle that may have an impact on death is a Tax-Free Savings Account (TFSA). While most Canadians understand the tax-free benefits of a TFSA, few are clear about the implications of death on this type of registered plan. TFSA’s are generally passed to beneficiaries tax free. To continue tax-free growth after death, contribution room would normally be required by the beneficiary, unless a spouse or common-law partner receives the asset.
When someone other than a spouse or common-law partner is the beneficiary, a TFSA will not be subject to taxation until the end of the calendar year following the year of death. Furthermore, tax will only be payable on funds that accumulate in the TFSA after the date of death.
If an investor is using a TFSA as a long-term investment it’s a good idea to name a beneficiary. A beneficiary designation will allow money to bypass the estate and be paid directly to the beneficiary without incurring probate taxes.
Beneficiary designations are only available on certain types of products such as RRSPs, RRIFs, TFSAs or life insurance policies. In these situations, funds go directly to the beneficiary upon death and bypass the estate and probate taxes.
It is not in anyone’s best interests to avoid advance planning on how to minimize taxes at death — and maximize benefits to be passed on to loved ones. Although for most people, death is not an enjoyable subject to contemplate, it is going to occur, and hiding your head in the sand will not only not help you to avoid it, it may cause you to hurt those whom you care most deeply about. Speak to a financial advisor or qualified tax professional and ensure your ducks are properly lined up. The information in this article is not intended to constitute legal, financial planning or investment advice, and it may not be relied upon for such. Please seek specific professional advice with respect to your particular circumstances, as each client’s financial situation is unique and solutions may vary. The strategies discussed herein are general. Mutual funds are not guaranteed and their values fluctuate on a daily basis. Investments may decline in value and investors may or may not receive back the original amount invested.
* Joel Attis is a Financial Advisor with AttisCorp Financial Group, Inc. in Moncton. Mutual funds are provided through Investia Financial Services Inc. Comments or questions may be submitted to joel@attiscorp.com, or he may be reached at 855-1155.