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It is a sad occasion when someone dies. Unfortunately, at this difficult emotional time those grieving must also deal with the difficult legal and financial issues of their loved one’s estate. Understanding the tax implications of death can help you plan for those you leave behind. The specific tax rules related to the death of an individual can be complex, but we can outline the basics.
Unlike many countries, there is no “inheritance tax” in Canada. When we die, our estate must pay all of the taxes we owe before any estate assets are distributed to our beneficiaries. This means that if you inherit assets, like the family cottage, boat or cash, there are no tax implications to you; the estate has already paid the tax. You will, however, be taxed on any income generated by that inheritance in the future.
When an individual dies, Canada Revenue Agency (CRA) deems them to have disposed of all of their assets immediately before their death at fair market value. In general, any income that has not been previously taxed, such as wages, pension income, interest or capital gains, are taxed on the individual’s final tax return. Any income that accumulates on those assets after the death of the individual but before the estate has been distributed to the beneficiaries is taxed at the personal marginal tax rates on an estate tax return.
For non-capital property, such as cash or term deposits, there are no tax implications on death. These are already “after tax” investments. Since we are taxed only on income, there may be tax owing on any interest that has been earned in the year, but not on the principal balance itself.
If the individual owned capital property, other than their principal residence, which had appreciated in value, this would trigger capital gains. Currently 50% of capital gains are taxed, so half of any capital gain will be included in the individual’s income in the year of death. Any capital losses can be applied against these capital gains, and in the year of death, any unused capital losses can be applied against any type of income on the final tax return. If there are excess capital losses, they can be carried back and applied against income in the year preceding death.
Determining capital gains once an individual has died can be difficult. It often means tracing back through history to determine when an asset was purchased and for how much, as well as determining what the current fair market value would be. Of course, the person most likely to know all of this information, the deceased, is gone. If a business was involved, the situation becomes even more complicated, as that too is deemed to be disposed of.
There are instances where capital property can transfer to a beneficiary on a tax-deferred basis. Most capital property can be transferred on a tax-free basis to a surviving spouse or spousal trust. This will defer the taxation on any capital gains that have accumulated on the property until it is either sold, gifted, or the surviving spouse also passes away. RRSPs can transfer tax-free to a spouse or to financially dependent children. Farm property can transfer on a tax-deferred basis to children, provided some specific criteria are met.
At death, when property transfers to beneficiaries there may also be probate fees. Probate is a fee for the courts to certify that your executor has the right to execute parts of your will. In British Columbia, there is no probate fee on an estate with a gross value of less than $10,000, a $208 fee on gross estate value from $10,001 to $25,000, $208 plus 0.6% on gross estate value from $25,001 to $50,000, and $358 plus 1.4% of gross estate value on estates over $50,000. On an estate of $600,000, probate fees in B.C. might be in the area of $8,000. Some people do a great deal of work to avoid probate fees, using multiple wills, gifting assets before death, designating beneficiaries on RRSPs, and other plans. Be certain that the extra legal and professional fees associated with these arrangements will justify the savings, and not trigger unexpected tax consequences.
So, What Can You do to Assure Those Left Behind Have an Easier Time?
1. Leave a current, valid will. Your will is your primary estate planning tool. It is essential not only for tax minimization, but also to ensure that your estate is distributed according to your wishes. A good will provides peace of mind, and makes the difficult task of distributing an estate much easier.
2. Keep good financial records and leave instructions in your will on where they can be found. If you have the proper documentation for purchases and costs associated with assets, it is far easier and less expensive to establish any capital gains or losses.
3. Make sure there is sufficient cash or insurance to cover the expenses associated with your passing. In addition to taxes and probate there may be professional fees.
Estate planning is complex and the specific rules can be confusing. The specific situation of each individual must be carefully considered; professional advice is important. But planning your estate could be the most important business you need to take care of.
By Wendy Lewis, CA. Published in the Comox-Valley Record. For more information, please contact your local MNP advisor or Wendy at 250.338.5464.
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