My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, January 26, 2015

The Two Certainties in Life: Death and Taxes - Impact on Your Personal Income Tax Return

Last week you read that upon your death, you are deemed to have disposed of your assets for income tax purposes (unless you leave them to your spouse). Today, you'll get a closer look at these rules.

For purposes of this post, I am assuming your spouse has predeceased you, or you leave your property to someone other than your spouse; so that there is not a tax-free transfer available upon your demise.

General Rule


Upon death, you are deemed to have disposed of your property for proceeds equal to its fair market value (“FMV”). This is known as a deemed disposition. The deemed disposition being equal to the excess of the FMV over the adjusted cost base of the property (“ACB”). For example, say you purchased 1000 shares in Blunt Bean Inc. for $150,000 and the shares are worth $275,000 upon your death. Your executors would have a $125,000 capital gain to report on your terminal tax return (final return from Jan 1st of the year you die to the date of your death).

For most people, there are two basic categories or property upon death, those being non-depreciable capital property and capital property.

Non-Depreciable Capital Property


Non-depreciable capital property would typically include shares, bonds, land (note: depending on the circumstances, land may not be capital property) and partnership interests. As noted above, upon death you are deemed to have disposed of your non-depreciable property for proceeds equal to its FMV. To be clear, that means the $125,000 capital gain in the example above is reported on your terminal return, notwithstanding you never sold the shares of Blunt Bean Inc. Thus, upon your death, for tax purposes you have in essence been “deemed” to have sold all your non-depreciable capital property even though there is no actual sale.

If you left the shares of Blunt Bean Inc. to your daughter, the ACB of the shares to her will become $275,000, which accounts for the fact your estate already paid tax on the increase in value from $150,000 to $275,000.

If the deemed disposition results in a capital loss, the losses offset any capital gains on the terminal return. If your capital losses exceed your capital gains in your final return, you can then deduct those excess losses against other income in the year of death, or in the previous year to the extent you have not previously claimed the capital gains exemption.

Principal Residence


Your principal residence is technically subject to the deemed disposition rules. However, if you only have one house (no cottage) and have lived in that house since it was purchased, your estate will typically be able to claim the principal residence exemption on your behalf and that property will be tax-free. It is important to note that your estate may have a capital gain or loss when it sells your principal residence, if the value of your principal residence has increased or decreased from the deemed value on the date of your death. This can occur where it takes a while to sort out the estate and the principal residence is not sold for months or even years.

Some Exceptions to the Deemed Disposition Rules


There are a couple significant exceptions to the deemed disposition rules:

(1) There is no deemed disposition on your cash holdings; however, if you hold foreign currency, you could have a foreign exchange gain.

(2) There is also no deemed disposition on your TFSA; however, there are various rules relating to what happens after your death to your TFSA. Taxtips.ca has a good summary here.

Depreciable Capital Property


Depreciable capital property would typically include buildings owned for rental purposes by the deceased taxpayer, and equipment used in an unincorporated business.

For depreciable property the same deemed disposition rules apply. However, there can also be recapture of prior depreciation (capital cost allowance claimed) where the FMV exceeds the undepreciated capital cost allowance (“UCC”) or instead of a capital loss, there may be a terminal loss where the deemed proceeds are less than UCC which can be used to offset other income in the year of death.

RRSP/RRIF


At the date of your death, the value of your RRSP or RRIF is included as income on your terminal return. For example, if your RRSP has a FMV of $560,000 on the day you die; your terminal return would reflect income of $560,000. The estate is supposed to receive a tax slip for the $560,000 RRSP/RRIF value upon death, but it has been my experience, that these slips are often not issued or are issued incorrectly, so you need to be diligent that the correct value is included on the terminal return. (As noted at the outset, I have assumed your spouse has already passed away, so the RRSP cannot be transferred tax-free to your spouse. However, the tax may be deferred if the beneficiary is a financially dependent child or grandchild under 18 years of age, or a financially dependent mentally or physically infirm child or grandchild of any age).

Note: See the comment section below for an interesting point made by Jean-Pierre Laporte about using a personal  pension plan to avoid the deemed disposition in relation to RRSPs.

Asset Rich but Cash Poor


Under the deemed disposition rules, it is possible to have a large deemed capital gain and a large associated income tax liability, yet not have the liquid assets to pay that liability. For example, you have significant real estate assets that appreciated considerably before your death, but little cash. In these cases, the estate may qualify to file form T2075 which allows for taxes to be paid in ten or less annual installments, with interest. In order to utilize this provision, security would have to be provided to the CRA.

The above is just a general overview of the income tax rules upon death. There are various other detailed rules I have not discussed that may relate to the death of an individual. Next week, I finish this discussion when I review the rules relating to the ownership of shares of a private corporation.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.