Is There an Inheritance Tax in Canada?
In Canada, there is no direct tax applied to inheritances. However, this doesn't mean that property and assets left to heirs are entirely tax-free. Instead, taxes are applied to the estate of the deceased before it is distributed to the heirs. Essentially, it's the deceased's estate that is subject to taxation rather than the heirs themselves.
These estate taxes are determined based on specific principles and regulations, including:
Deemed Disposition: When a person passes away, the Income Tax Act treats it as if some of their assets were sold at their market value. This concept is referred to as "deemed disposition." It applies to most types of property. The proceeds from this deemed disposition are used to calculate the capital gain, which is the difference between the original purchase price and the market value at the time of death. Half of this capital gain is subject to taxation.
Property Subject to Deemed Disposition: Deemed disposition applies to the deceased's capital property, which includes income properties and non-registered investments (e.g., securities, mutual funds, ETFs).
Exceptions: There are exceptions and conditions to the deemed disposition rule. For example, property transferred to an eligible spouse does not undergo deemed disposition and is not taxed until the death of the surviving spouse. Additionally, the capital gain on the deceased's principal residence is not taxable, and life insurance death benefits paid to beneficiaries are also not taxable.
Deemed Withdrawals: For registered plans such as RRSPs or RRIFs, a different rule applies upon death called "deemed withdrawal." All registered investments are considered to have been withdrawn at the time of death, and the full amount is taxable. However, there are strategies to limit taxes on registered investments upon death.
Income for the Year of Death: Outstanding income that was accrued by the deceased but not collected and earned income up to the date of death must be included in the deceased's final tax return. Special returns may apply to certain types of income.
Duties of the Executor: The executor (or liquidator in Quebec) is responsible for meeting legal requirements and settling the deceased's estate. Before distributing assets, they must notify the Canada Revenue Agency of the death, file necessary tax returns, obtain notices of assessment, and pay or secure all amounts owing.
It's important to consult with legal and financial professionals when planning your estate to ensure your wishes are carried out efficiently while considering the tax implications. Estate laws are complex, and your situation is unique, so proper planning is crucial.