What types of assets are tax exempt?
The gain on the sale of a principal residence for tax purposes is not taxable (i.e., the principal residence exemption (“PRE”)), and as such, the proceeds from the subsequent sale of a principal residence of a deceased taxpayer may be distributed tax-free to the Beneficiaries. (Note that since the 2016 tax year, dispositions of principal residences must be reported on the T1 personal tax return, regardless if the PRE applies.)
What options are there for reducing the taxes paid by my beneficiaries?
In general, under the Canadian Income Tax Act (the “Act”), a deceased taxpayer is deemed
to dispose of their worldwide assets at fair market value (“FMV”) immediately before death. As a result, any accrued gains on their property may be subject to income tax. (For example, shares of privately held Canadian corporations are considered property of a deceased taxpayer, and any gains and the value of these shares will be subject to tax upon the shareholder’s death.). In some cases, property may be transferred (i.e., a rollover) on a tax-deferred basis to a spouse, common law partner, qualifying spousal Trust, Registered Disability Savings Plan (RDSP) or a Lifetime Benefit Trust.
Specific to holding farm property, there are rollover options (subject to strict rules) for transfers from parents to children either prior to or after death.
Provided below is a summary of the tax consequences of assets held by an individual at the time of their passing (the “deceased taxpayer”):
-
- Principal Residence: The gain on the sale of a principal residence for tax purposes is not taxable (i.e., the principal residence exemption (“PRE”)), and as such, the proceeds from the subsequent sale of a principal residence of a deceased taxpayer may be distributed tax-free to the Beneficiaries. (Note that since the 2016 tax year, dispositions of principal residences must be reported on the T1 personal tax return, regardless if the PRE applies.)
- Registered Investments: The deceased taxpayer will be deemed to have disposed of the assets held in a registered plan at the date of passing and will be liable for income taxes on the fair market value of the assets. To mitigate the tax liability, the deceased taxpayer may name a spouse as Beneficiary of the registered plan or may rollover the proceeds from the registered plan to either a Lifetime Benefit Trust or an RDSP on behalf of eligible Beneficiaries.
-
- Non-Registered Investments: The deceased taxpayer will be deemed to dispose of these investments at their fair market value (“FMV”). To mitigate the tax liability, the deceased taxpayer may rollover certain capital property to a spouse.
-
- Private Company Shares: The deceased taxpayer will be subject to possibly two taxes on account of holding shares of a private company at the time of passing. The first tax transaction (“deemed disposition tax”) occurs on death, deems the shares to have been sold, and is calculated on the gain of the value of the private shares. The second tax transaction (“deemed dividend tax”) occurs when the estate redeems the private shares, deems a dividend to have been paid to the estate, and is calculated on the excess of fair market value of the private shares over the paid-up capital (usually nominal in value) of the private shares. There are various strategies that can be used to minimize the double taxation effect, which may include the use of an incorporated holding company to acquire the shares of the private company from the estate.
-
- Farm Property: The deceased taxpayer will be deemed to dispose of the farm property (the “property”) at its fair market value (“FMV”) at the time of passing. For dispositions of qualified farm property (“QFP”) after April 20, 2015, a lifetime capital gains exemption of $1,000,000 (the “LCGE”) is available.
-
- Personal Use Property: The deceased taxpayer will be subject to capital gains tax on certain personal use property items greater than a $1,000 in value (i.e., paintings, rare coins) at the time of passing (although these items are usually purchased by a third party at an agreed upon price).