Recently I wrote a piece on how to handle an inheritance and got a few questions from RetireHappy readers. One of the areas greatly misunderstood in Canada is issues around taxation when you die and when you inherit money so I thought I would address some of these common questions.
Is there inheritance tax in Canada?
In Canada, there is no inheritance tax. If you are the beneficiary of money or asset through an estate, the good news is the estate pays all the tax before you inherit the money. Technically, once you inherit money, the tax has already been paid. You do not have to add inheritance to your income tax return.
What about estate tax?
Often estate tax refers to taxing the value of the estate. In Canada, Canada Revenue Agency (CRA) does not tax the assets of an estate but they do require that all of the tax owing on income up to the date of death be paid. The government taxes your income but not your assets.
With regards to income tax, both the Federal Government and the Provincial government gets taxes when you file your annual income tax return. When someone passes away, the executor must file a final tax return as of the date of death. The tax return would include any income they received since the beginning of the calendar. Some examples of income include Canada Pension Plan (CPP), Old Age Security (OAS), Retirement Pensions, Employment income, dividend income, RRSP and RRIF income received, etc.
Related article: Understanding Canadian Tax Brackets: Marginal Tax vs Average Tax
With regards to your assets, it's important to understand that all of your assets are deemed to have been “sold” just prior to death for tax purposes. This would include real estate, land, businesses, investments and your RRSPs. Here are a few common examples of how this “sale” of assets can create income tax at death.
- Joe has $100,000 in RRSPs. When he passes away, the $100,000 RRSP is deemed to have been cashed in and on Joe's final tax return, $100,000 of RRSP income will be added to his other sources of income.
- Let's pretend Joe's money was in a RRIF instead of an RRSP and Joe had already received $5250 of income from monthly RRIF payments prior to his death. On Joe's final tax return, there would be $5250 of RRIF income and then another $100,000 of income from the asset.
- Another common example comes from Real Estate, whether it's an investment property or a recreational property. Let's pretend Elizabeth has an investment condo that she has owned and rented out for over 15 years. When Elizabeth passed away on June 30th, her condo is deemed to have been sold for tax purposes. Let's say she paid $150,000 originally for the condo and now it's worth $275,000. There is a capital gain of $125,000 of which 50% is taxable. Elizabeth's final tax return would have to show net rental income for 6 months of the year plus the $67,500 of taxable capital gains.
- Stacy has a cottage at the lake that she inherited from her parents 22 years before she passed away. The cottage has been in the family for multiple generations and rumor has it that the land the cottage was built on was originally bought for less than $1000. When Stacy passed away at the age of 77, the cottage was deemed to have been sold for tax purposes for $850,000. When she inherited the cottage the value of the cottage was $725,000. Her parents would have paid for any capital gains prior to Stacy inheriting the property. Stacy's final tax return needs to show the $67,500 of taxable capital gains (50% of $850,000-$725,000).
- The last example is for those that pass away with non-registered investments like stocks or mutual funds. Barry worked for the same company for 32 years and as a result held $325,000 worth of stock of the company he worked for. When Barry passed away, the stocks were deemed to have been sold for tax purposes. the adjusted cost base (ACB) of the shares were calculated to be $110,000. At death, Barry has $215,000 of capital gains of which 50% is taxable. Barry's final tax return must show $107,500 of taxable capital gains plus and dividends he would have received from the beginning of the calendar year.
As you can see from these examples, the deemed disposition (sale of assets for tax purposes) can potentially trigger a lot of taxation. In any of these examples, if there was a spouse as a beneficiary, there would be some rollover provisions where the tax may not be triggered now but deferred until later.
Are there other taxes on assets at death?
What we've talked about so far is the tax when you earn income. Remeber that at death there is no tax on the asset but there is a potential deemed disposition of the asset for tax purposes.
In addition to income tax, provinces will have what is commonly known as probate fees. Probate fees vary from province to province and are based on the total assets of the estate. Let's use Jake's estate as an example:
- Personal residence = $590,000
- Bank account = $22,000
- Cottage = $225,000
- Non-Registered Investments = $85,000
- RRSPs = $90,000
- TFSA = $48,000
- Life insurance death benefit = $150,000
For probate purposes, assets with a named beneficiary like life insurance, RRSPs, and the TFSA are not included. They are deemed to bypass probate with the direct beneficiary designation unless the designation is the estate. In addition to these direct beneficiary designated assets, joint assets are typically not included for probate because the surviving joint owner becomes the owner of the asset.
So, in Jake's example, his total estate would be worth $922,000 (1+2+3+4)
If Jake Lived in Alberta, the total probate fees would be $525
If Jake lived in BC, his total probate fee would be about 1.4% of the total value of the estate = $12,900
If Jake lived in Ontario, his probate fee would be about 1.5% = $13,800
If Jake lives in Halifax, his probate fee would be about $15,000
As you can see, every province and territory has different probate fees. TaxTips.ca has a great resource outlining all the current probate fees across the country.
Related Article: Understanding Taxes and Probate Fees
Putting it all together
So in Canada, there is no inheritance tax and technically no estate tax (where you pay a tax based on the total assets of the estate). There is, however, income tax based on the final tax return of the deceased filed by the executor and probate fees determined by each of the provinces. Probate fees and income tax are distinct and separate. If we look at Jake's example, there would be income tax on the $90,000 RRSP at death but no probate fees on the RRSP if it had a direct beneficiary designation.
Estate planning and taxes can be complicated. Because everyone's situation is different and unique it's always advisable to seek professional help from a financial advisor, accountant or lawyer.