TAXATION ON DEATH
We all know the saying about death and taxes. Although both are certainties in life, your death will often result in additional tax payable for reasons discussed below.
Deemed disposition rules
When you die, you will have a deemed disposition of most of your capital properties at their FMV. For any given property, if the FMV is greater than your cost, you will have a capital gain, and half of that amount will be included in your income as a taxable capital gain (“TCG”). The person acquiring the property as a result of your death (for example, under your will or under intestacy laws) will have a deemed cost of the property equal to that FMV.
Conversely, if the property has an accrued loss, the deemed disposition will result in a capital loss. One-half of the loss will be an allowable capital loss (“ACL”). Normally, ACLs can offset only TCGs and no other forms of income. However, in the year of death and the immediately preceding year, ACLs can also offset other forms of income (technically, the amount of ACLs that can offset other sources is the ACLs net of any capital gains exemption that you have claimed).
There is an exception for property left to your spouse (all references to a spouse include common-law partner), or a qualifying trust under which your spouse is the beneficiary. In such case, the deemed disposition and acquisition take place at your tax cost of the property. In other words, it is a tax-free “rollover”. However, your legal representative (such as your executor) can elect out of the rollover on a property-by- property basis. Electing out of the rollover means the property is subject to the deemed disposition at FMV. This may be beneficial if the property has an accrued loss, because the loss will be triggered. Alternatively, it can be beneficial if the property has an accrued gain that can be offset by your losses, as this will result in a higher cost for your spouse.
Example – electing out of rollover
You leave some real property to your spouse under your will. Your cost is $100,000 and the FMV of the property at the time of your death is $250,000. You have at least $75,000 in unused net capital losses from previous years.
If your legal representative elects out of the rollover, you will have a deemed disposition at $250,000, resulting in a $150,000 gain and $75,000 TCG. The TCG can be offset by your $75,000 of net capital losses, resulting in no tax payable for you on your "terminal" return. The benefit is that your spouse’s cost of the property is $250,000, rather than the $100,000 that would apply if the rollover took place.
Deemed disposition for RRSPs and RRIFs
This can be one of the most significant items included in your income in the year of death. As a general rule, the FMV of your registered retirement savings plan (RRSP) at death is included in your income. If this rule applies, the beneficiary of the amount receives it tax-free.
An exception applies, generally where you leave the RRSP to your spouse (or common- law partner), or to a child or grandchild who was financially dependent upon your for support. For this purpose, the child or grandchild is deemed not to be financially dependent upon you if their income for the year preceding the year of death exceeded the basic personal credit amount (plus, if they are disabled, the disability credit amount), unless it is otherwise established that they were dependent upon you. Your spouse does not have to be financially dependent upon you.
Where the exception applies, you do not include the RRSP amount in your income. Instead, your spouse, child or grandchild includes in income the amount they receive from the RRSP. However, they may be eligible for an offsetting deduction. For example, if your unmatured RRSP was left to your spouse, she would include the amount received from the RRSP in her income, but she could use the amount to make a contribution to her own RRSP, or to acquire an annuity payable for life or up to 90years of age, and get an offsetting deduction. Similar rules apply to an RRSP left to a child or grandchild who was dependent upon you by reason of mental or physical infirmity. If the child was not infirm, an offsetting deduction is allowed only if the child is under 18 years old and the amount is used to acquire an annuity payable up to an age not exceeding 18. In each such case, the contribution to their RRSP or acquisition of the annuity must take place in the same year in which they receive the assets or funds from your RRSP, or within 60 days after that year.
Similar deemed disposition rules (and exceptions to the rules) apply if your RRSP had been converted to a registered retirement income fund (RRIF) and you owned the RRIF at the time of your death.
Accrued amounts to date of death
Another rule provides that amounts payable periodically that have accrued to the time of your death are included in your income, even if they were not received by you. This category includes items such as interest accrued to the date of your death, and any salary or wages that accrued to the date of death. For example, if you are paid a monthly salary at the end of each month and you die half-way through a month, the half of that month’s salary that accrued to your death would be included in your income.
Rights and things
The value of “rights and things” at your death may be included in your income. This category includes items such as declared but unpaid dividends on any shares you own, and any earned but unpaid employment income from a prior pay period. For example, if you died in the month of May and had not yet received your pay cheque for the month of April, the April salary would be a right or thing.
Although the rights and things are included in your income, your executor can elect to report them in a separate tax return rather than in your regular tax return for the year. The election must be made by the later of one year after your death and 90 days after the CRA sends a notice of assessment for the regular return. The main benefit to filing the separate return is that the rights or things are subject to a separate set of graduated tax rates, rather than being “stacked” on top of your other income in the regular return at your marginal rate of tax in the regular return. Another benefit is that you can double up on some of the personal tax credits and claim them in both returns – including the basic personal credit, the spousal credit, and the age credit.
However, if a right or thing is distributed to one of your beneficiaries within the time limit for filing the election, it is not included in your income in the regular return or separate return. Instead, it is included in the beneficiary’s income when the right or thing is realized or disposed of.