Managing the estate’s tax burden is an important part of the estate planning process. Fortunately, Canada makes taxation relatively easy on decedents and heirs alike.
While your heirs will not be directly taxed upon your death, your estate will. With a solid estate plan in place, your executor should have a relatively easy time filing your final tax return.
Here is everything you need to know about how the legacy you leave to your family will be taxed. If you have recently inherited property, this guide will also help you understand where your tax obligations are likely to lie.
Tax obligations begin with a final tax return prepared by your executor or estate administrator. The executor pays all of your final taxes out of the estate, as well as any back taxes, fees, and interest penalties. Your heirs, however, will not pay an estate tax. There is no inheritance tax, estate tax, or death tax in Canada.
Are there ways to reduce or eliminate estate tax?
No, because you are not really paying an estate tax. Your estate is just paying your final income tax return. The tax return will include employment income, OAS and CPP/QPP benefits, pensions, employment insurance benefits, dividends, interest, and capital gains. The executor should be making sure that they’re getting the benefit of all tax credits and deductions, just as if they were creating a tax return for a living client.
Once the taxes have been paid the CRA will issue a clearance certificate to the executor. This means that the CRA is satisfied and that heirs may receive their inheritance without fear that the CRA will come back and ask for more money. The executor will generally ask the beneficiaries to sign a release at that time. One of the purposes of that release is to verify that the beneficiaries are satisfied that the estate’s tax liability has been handled, and handled correctly.
If the executor fails to get this certificate, they may be held personally liable for any amounts the deceased owed unless the beneficiaries sign the release. If beneficiaries sign the release then the beneficiaries may be held accountable, so due diligence is called for.
This is good news. It means there are no special tricks that you need to employ while estate planning. You only have to use whatever strategies you’re using to manage your income tax.
In addition, the government stops taxing you on your death date, which means your estate is only paying income taxes on the months-to-date.
Do I have to pay tax on an inherited home in Canada?
It depends on what you do with the home.
If you live in the home then you won’t have to pay any special taxes on the home other than your annual property tax.
If you rent out the home then you’ll pay income tax on your rental income.
If you sell the home then you’ll pay capital gains tax. Capital gains tax is not the same as an inheritance tax or estate tax. Capital gains is an amount paid on the profit you make on the home.
For most heirs, capital gains tax will not be very high. That is because the law treats the home a little like it was sold at death; from the decedent to the estate. That means the fair market value of the home at death gets used to calculate capital gains tax, rather than the amount the decedent originally bought the home for.
If the home was valued at $200,000 when the decedent passed and an heir sold it for $210,000 they’d only pay capital gains tax on 50% of the $10,000 profit, or on $5,000. That $5,000 gets added to their income to the year and their entire income is taxed at whatever their tax rate is.
Do I have to declare inheritance money as income?
For the most part, no. The estate has already paid the necessary taxes. You don’t even have to report your inheritance to the CRA if the inheritance consists of cash only. You also don’t have to report to the CRA if you’ve become the beneficiary of a trust.
There is an exception: if you invest inheritance money you can still pay capital gains taxes on income made on the investment. Obviously if you use the inheritance money to purchase an income-bearing asset the income created by the asset can still be taxed.
For example, if you use your inheritance money to buy a rental property then you can be taxed on the rent. So you’d claim the rent as income, but you wouldn’t claim the big check you got from the estate as income.
What if a beneficiary inherits overseas property?
If you take possession of a “specified foreign property” you should file a T1135, a Foreign Income Verification Statement if the property is worth more than $100,000. This includes intangible property like patents, copyrights, and IP as well as tangible property like stocks, bonds, and real property held outside of the country.
Once you have inherited foreign property it’s usually wise to consult both with an attorney and with an accountant to make sure the tax implications of these new acquisitions are being handled correctly. Often you will have to file taxes in the country where the asset is held, as well.
Need help with estate planning?
Worried about the tax implications of your estate planning? Want to make sure your assets are distributed according to your wishes?
Contact the experienced estate planning attorneys at Merchant Law. Our lawyers have decades of experience handling wills and estates. Many of our attorneys also have a background in real estate and business law, which can help us handle the most complex estates.
Need to challenge a will? Having trouble with an executor? We can help with these issues as well.
Call (780) 474-7777 to schedule an appointment.