What is Scarier than Death and Taxes?
Did you know that at death you are deemed to have sold your assets at its fair market value? The difference between the fair market value at death less the original cost or purchase price will determine the capital gain to be included on your final tax return. For example, Bob died holding IBM shares worth $600,000 that he bought for $400,000. He would report a capital gain of $200,000 on his final return.
If, however, the assets are transferred to a surviving spouse the gains can be suspended. The tax would be deferred until the assets are sold or the surviving spouse passes. Continuing the example above, Bob leaves behind his wife Anne and his assets are transferred to her at his death. There would be no capital gain included for Bob and Anne would receive his shares at their original cost of $400,000.
In some circumstances you may want to elect out of transferring the assets to the spouse at cost to trigger capital gains in the estate. This can be done on an asset-by-asset basis. You would do this if there were capital losses in the estate that could be utilized to offset the capital gain or to use up low tax rates.
In addition to the deemed sale of your assets you are also considered to have withdrawn any remaining funds in registered plans such as RRSPs and RRIFs. Unlike the assets discussed above the entire amount would be considered income vs a capital gain. These registered plans can also be transferred to a surviving spouse without tax implications until there is an actual withdrawal or the spouse passes.
What happens to your family home or cottage? No different than the assets described above, you are deemed to have sold the properties at fair market value unless transferred to your spouse. You can also utilize the principal residence exemption. The principal residence exemption provides an exemption from tax on the capital gain realized when you sell property that is considered a principal residence. Note – only one property per year, per family can be designated. If the property is ordinarily inhabited each year, the family home and/or cottage can be designated as the principal residence. As it is allocated on a year-to-year basis, you will want to calculate how to best apportion the exemption between properties.
Shares of Private Companies:
The deemed disposition of shares of a private company can result in a significant income tax liability at death. The issue is often compounded by the fact that the tax obligation arises on the deemed disposition of an illiquid asset meaning that funds to cover the tax may not be readily available. In addition, if the private corporation holds appreciated assets such as real estate, without proper planning double or even triple tax can result. In order to avoid adverse tax consequences proper estate planning is essential.
Ways to Minimize tax at death?
Unfortunately, there is no way to eliminate tax at death, but it can be managed and minimized. Proper estate planning can result in significant savings in income tax and Estate Administration Tax (Probate). Often this exercise starts with an assessment of the terminal tax liability based on present circumstances, followed by an analysis and recommendations of how that result can be improved. Some of these opportunities include the acceleration of income during lifetime from RRSP’s or unrealized capital gains to take advantage of lower income tax brackets, or medical or donation tax credits. More sophisticated planning can involve an Estate freeze in order to transfer income tax to the next generation. Trusts are extremely flexible vehicles in the context of Estate planning and can result in significant savings in Probate fees along with other benefits.
If you do not feel you have your Estate Planning in order, talk to us. No better time than Halloween.