When a loved one passes, the last thing on most people’s minds is taxes, but they play an important role in settling the estate. In Canada, there is no inheritance tax.
You don’t have to pay taxes on money you inherit, and you don’t have to report it as income. But this doesn’t mean your inheritance is immune from taxation.
Thinking about gifting your home or assets to your children? Click here for tips on navigating this process.
Why is There No Inheritance Tax?
The reason is that the estate pays taxes before the beneficiaries receive their inheritance in Canada. This doesn’t mean property and assets left to heirs will not be taxed. These taxes are applied before the estate is distributed.
It’s as if the deceased were being taxed rather than their heirs. When doing estate planning, it’s critically important to factor in taxes the estate must pay before the beneficiaries receive their inheritance in Canada. This should always be done with tax and financial experts and estate planners.
From a real estate perspective, the estate administration tax is more commonly known as probate. As a Seniors Real Estate Specialist (SRES), I frequently get contacted by the executors of estates following a person’s death to provide an opinion of the value of the deceased’s home. Estate assets must be valued at fair market value at the decedent’s date of death.
Typically, people’s most valuable asset is their home. Executors need to know the estate’s value to calculate the probate fee paid when they apply for the certificate of appointment—the probate fee in Ontario is 1.5% of the estate’s gross value above $50,000.
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Are Principal Residences Exempt from Probate Tax?
It’s a common question: Principal residences in Ontario still count towards the total estate’s value and, as such, are subject to probate fees. Upon administering and finalizing the estate, they may also be subject to capital gains tax.
However, some exceptions may apply in some instances. For example, if the deceased owned the property jointly with another person, such as a spouse, the surviving owner may be able to avoid probate entirely. It’s always best to speak with a qualified legal professional to determine what taxes and fees may apply to your case.
The estate executor must ensure taxes are paid for the last year of the person’s life before passing away. If you inherit real estate in Canada, the property’s cost to you is equal to the deemed proceeds of disposition for the deceased person. Usually, this amount is the property’s fair market value right before the person’s death.
However, there are exceptions to this rule. For example, when you inherit property because your spouse or common-law partner died if owned as joint tenants, it will pass tax-free because of the right of survivorship.
What Happens When You Sell an Inherited Property?
When I work with executors, a common question is whether the beneficiaries will owe capital gains tax on the sale of property. The capital gain, or profit, on the deceased’s principal residence is not taxable. If the deceased had more than one residence, a calculation can be performed to determine the capital gain on each residence. Then, the option that involves lower taxes can be selected.
What is deemed disposition, and will it apply to all property in your estate? Not all property. By definition, a person who has died is considered to have disposed of all their property right before death. If the person owns an investment property, the deemed disposition can result in a capital gain or loss.
What is Capital Loss?
According to the CRA’s website, a change in the fair market value of a capital property between the time it was purchased or acquired and the date of death results in a capital gain or capital loss, which must be reported in the final tax return of the person who died. The capital gain is taxable, referred to as the taxable capital gain. A capital loss is referred to as an allowable capital loss.
When reporting on the deceased’s final tax return concerning real estate, it must be determined whether the property is a principal residence or used to generate income. Typically, a principal residence is exempt from tax. Capital gains tax or capital losses must be calculated and reported on the final return if it’s a secondary or income-producing property.
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Will I be Taxed if I Sell the Family Cottage?
One of the most talked-about real estate conversations I have with older adults is about their cottage. This can be even more complicated when multiple children are set to inherit the property. In recent years, the concern has become the amount of capital gain tax potentially owed.
When properties like cottages have been in families for generations, the growth in value from the original date of purchase to the owner’s death is typically significant. In many cases, if the beneficiaries don’t have the funds to pay the gain, the parents will factor that into part of their estate planning. Hence, funds are available to pay the capital gains tax, and the family can continue enjoying the cottage. Other factors exist, such as family dynamics. No parent wants to see their kids fight and argue over the cottage.
I have seen situations where the argument over the family cottage became so contentious that nobody got to use it; the cottage wasn’t maintained and just deteriorated away. Eventually, the cottage was sold after sitting dormant for twenty years. I’m sure that wasn’t the intended legacy their parents had. In recent years, I’ve found it more common for the cottage to be sold before death, and parents will gift the money to their kids if they don’t require the money from the sale proceeds to fund their retirement. This strategy is an excellent legacy because the parents can watch their kids enjoy their part of the inheritance while they’re still alive, which is gratifying for them.
If you do decide to keep the cottage in the family, here are four potential options to consider:
- Make the adult children joint owners
- Set up a personal trust
- Buy permanent life insurance
- Designate the cottage as your primary residence
What About Basement Apartments?
What if your parent’s primary residence had a basement apartment they rented out to tenants? Is the sale of the home subject to capital gains tax? The simple answer is no. The principal residence exemption (PRE) will protect the sale from being subject to capital gains tax. From a Canadian tax perspective, renting out your basement doesn’t necessarily disqualify you from claiming the principal residence exemption, but there are important factors to consider.
The Canada Revenue Agency (CRA) generally allows homeowners to maintain their principal residence exemption even when renting out a portion of their home, provided certain conditions are met:
- The rental use is ancillary to the main use of the property as a residence
- The property has no structural changes to accommodate the rental
- No Capital Cost Allowance (CCA) is claimed on the property
If these conditions are satisfied, the CRA typically considers the entire property to retain its nature as a principal residence. You can still benefit from the tax-free capital gains when you sell your home.
Work With a Senior Real Estate Specialist
When estate planning, it’s important to talk with experts who specialize in the services you need to get the best advice possible to make good decisions. Working with a Senior Real Estate Specialist (SRES) will help you achieve this and add value. If you want to talk about your next chapter, please contact me.
Looking to downsize your home? I can help! Call 647.283.2127 or email me at stuart@stuartnodell.com to get in touch.
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