The death of a loved one is a difficult burden to handle and can be overwhelming for most. In addition, as the executor of an estate of a loved one, there are critical tasks, responsibilities and processes which will need to be addressed in a relatively short period of time. For this reason, understanding the tax issues that an executor will be required to address in advance will help ease this burden.
One of the main sources of tax implications related to an estate are capital gains. On death, there is a deemed disposition of all assets for fair market value. If there has been an increase in the value of a major asset, most commonly real property, since the time that particular asset was acquired, the estate will be responsible to pay capital gains taxes for approximately one half of the increase. This tax applies regardless of whether or not the estate sells the asset. However, there are a few exceptions to consider.
One of these exceptions involves any assets transferring to a surviving spouse, for example real property held in joint tenancy. In this case, the capital gains tax will be deferred until the surviving spouse sells the asset or dies, assuming there is no new spouse on title. Similarly, capital gains taxes in relation to any assets transferred to a spousal trust will also be deferred until the death of the surviving spouse. The trust will then be responsible for payment of the tax based on the current market value of the asset at the death of the last surviving spouse.
Depending on the type of asset, capital gains taxes can be reduced or eliminated if you gift or donate the asset to a registered charity. In addition, a donation receipt for the fair market value would be issued at the time of donation and could potentially produce tax savings on the final return of the estate.
Capital gains taxes do not apply to properties which are the principal residence of the deceased and are less than 1.2 acres in size. It is also important to note that the fair market value of the property for the purposes of capital gains is usually calculated as at date of death.
Registered plans (RRSP and RRIF) are taxed at the marginal tax rate of the deceased based on fair market value and taxes are payable by the estate on the final return. Your estate planning should also include the consideration of leaving a portion of the estate assets, using those funds to hold back for taxes due on the final return so that beneficiaries are not left with the burden of taxes.
Another tax implication to be aware of when dealing with an estate is Property Transfer Tax (“PTT”). PTT is payable on all transfers of real property, unless an exemption applies. If an individual receives an interest in a principal residence directly or an interest in a principal residence through an estate or trust which is created under the will of the deceased, they will not be required to pay PTT provided the following factors are also fulfilled:
- the individual receiving the interest is a Canadian citizen or permanent resident;
- the trustee or executor of the will is registered on title to the real property;
- the individual receiving the interest is a beneficiary of the estate or trust;
- the individual and the deceased fall under the definition of “related individuals” under the Property Transfer Tax Act at the time of death; and
- the real property was the deceased’s principal residence at the time of death or it was the individual’s principal residence for at least 6 months prior to the death of the deceased.
The third tax implication to keep in mind when dealing with an estate is probate tax. Probate tax is applied to the gross value of the estate, in British Columbia this tax is approximately 1.4%. There are various triggers for probate, most commonly real property, vehicles and bank accounts of a certain value will trigger probate tax.
If all assets are held in joint tenancy, therefore making the right of survivorship applicable, and if there is no deemed trust, probate tax can be bypassed. Another way to bypass probate tax is to designate a beneficiary on all registered plans. An important point to note however, is that if the deceased transfers all assets outside of the estate, the estate is still responsible for paying the taxes affiliated with registered accounts as well as the capital gains taxes affiliated with real property. Therefore, if the estate has a shortfall and cannot accommodate payment of these taxes the beneficiaries would then be responsible for clearing these taxes personally.
Capital gains, Property Transfer Tax and probate taxes can greatly impact the financial affairs of an estate. For this reason, it is important to make educated and informed decisions in regards to your estate plan. With a few extra steps taken today, your estate could be protected from a sizeable loss in the future. An important factor to always keep in mind however, are the frequents changes to these taxes, their exemptions and their application. An estate plan that can save your estate a loss today may not suffice in the future if the rules around these taxes are to change. It is therefore equally as important to review your estate plan regularly and consult with the appropriate professionals for further advice in order to ensure that your estate plan is providing as much tax relief as possible.