Large tax bills are an unpleasant surprise for many estate trustees.
Often, the bill is much larger than the deceased ever paid during their lifetime, especially if they had a modest income.
Why? Because Canadian income tax law deems the deceased to have sold their assets immediately before death, even if they were not actually sold and still have not been sold.
This is called a deemed disposition.
What Is a Deemed Disposition?
A deemed disposition means that, for income tax purposes, the deceased is considered to have disposed of certain assets immediately before death at their fair market value.
Although no money may have changed hands, the increase in value of those assets may still be taxable.
Common examples of deemed dispositions include:
- RRSPs and RRIFs (not TFSAs) (see below for more details)
- Unregistered accounts with stocks and investments
- GICs with accrued unpaid interest
- Rental properties and commercial real estate
- Cottages
- Vacant land
- Some business assets
Calculating the taxable income from a deemed disposition
For a deemed disposition, the deemed ‘price’ is the fair market value on date of death. As a result, appraisals and valuations are required for many assets (such as cottages and artwork) that are ‘deemed’ to have been disposed for tax purposes but which the estate trustee might not sell ever, or at least for some time.
In tax law, the cost of an asset is called the “adjusted cost base” or ACB”. Often, this is the original price paid plus any permitted expenses after purchase (such as renovations).
The taxable income from a deemed disposition is the difference between fair market value on death and the ACB. This amount of income (or loss) must be reported on the terminal return.
For example if the deceased owned a cottage that they bought for $20,000 and paid $40,000 renovate and improve, and it is now worth $200,000, then $140,000 must be declared as a taxable capital gain on the terminal return (which will lead to taxes being payable on $70,000 of income).
| RRIFs and RRSPs |
Many surprisingly large tax bills arise when the deceased had a substantial RRSP or RRIF when they died.
The entire value of each RRSP and RRIF on the date of death must be included in the income of the deceased on the terminal return. For instance, if the deceased died with a $200,000 RRIF, then $200,000 of taxable income must be reported on their terminal return (to be added to all other income for all other sources). As a result, often, there is tax bill on the terminal return of approximately 50% of the value of the RRSPs and RRIFs alone.
If, for instance, the deceased had an annual income of $40,000 and a $200,000 RRIF, then the inclusion of $200,000 in income on the terminal return is likely to create a tax bill of roughly $100,000 more than in regular years.
| Roll-overs |
Important note: deferral of taxes may be possible. Many assets, including RRSPs, RRIFs, investment accounts and other taxable investments such as a cottage can be ‘rolled over’ to a surviving spouse.
This roll-over defers the tax that would otherwise be payable. Taxes are only due later, when the surviving spouse sells the investment, withdraws funds from the RRIF/RRSP or, again, when there is a deemed disposition on their death.
Whether a roll-over is possible depends on a number of factors, including –
- whether there is a surviving spouse,
- any beneficiary designations on the account, and
- the Will.
Deferring taxes arising from the deemed disposition using a spousal roll-over is not simple and can create real liabilities for the trustee and surviving spouse. It requires proper analysis and require careful tax filings.
When a roll-over is claimed, usually we must also prepare and file the tax return for the surviving spouse for that year.
Note that a ‘spousal roll-over’ will not be available if the deceased was single at death (for instance, a widow or widower).
| The principal residence exemption |
One of the best-known exemptions from the general rule of taxation of deemed dispositions of assets is the ‘principal residence exemption’ (sometimes called the “PRE”).
When a homeowner dies, they are deemed to have disposed of their interest in all real estate for its fair market value. When a property was also the principal residence of the deceased, they may be eligible to claim that the gain is not taxable, if it qualifies for the principal residence exemption.
Note that the deemed disposition must be reported, and the exemption claimed.
We can help.
Our in-house estate tax team works exclusively with deceased taxpayers and estates, coordinated with our probate and estate settlement teams to guide and assist estate trustees at each step.
We can assist with:
- Terminal (Final) Income Tax Returns
- T3 Estate Trust Returns
- Optional Returns
- Review of capital gains and deemed dispositions
- RRSP and RRIF tax reporting
- Tax planning opportunities available after death
- CRA correspondence
- Clearance Certificate applications
Questions?
We are here to help. Contact Miltons Estates to discuss any aspect of your estate including tax obligations.
Miltons Estates – Tax Services.