Deemed Disposition: Inheritance Planning + Taxation

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

When a person dies in Canada, the Income Tax Act considers them to have sold or "disposed" of all their capital property immediately before their death. This is a hypothetical or "deemed" transaction, as there is no actual sale that takes place. The proceeds of this deemed disposition are considered to be the Fair Market Value (FMV) of the property at the time of death.

The Deemed Disposition rule applies to most capital property, including:

• Real estate: A cottage, rental property, or other non-principal residence. A principal residence may be exempt from this rule, subject to certain conditions.

• Investments: Non-registered stocks, bonds, and mutual funds.

• Other capital property: Art, jewelry, and other valuable personal belongings.

The purpose of deemed disposition is to trigger any accrued capital gains (or losses) on the deceased person's assets.

• Calculating the gain or loss: The capital gain or loss is calculated as the difference between the Fair Market Value (FMV) of the property at the time of death and its Adjusted Cost Base (ACB). The ACB is generally the original cost of the property plus any associated expenses.

• Taxable capital gain: In Canada, only 50% of a capital gain is taxable. This amount is included in the deceased's final tax return (often called the "terminal return").

• Tax liability: The deceased person's estate is responsible for paying any taxes owed as a result of the deemed disposition before the assets are distributed to the beneficiaries.

There are important exceptions to the deemed disposition rule that can help defer or reduce the tax burden:

• Spousal Rollover: If capital property is transferred to a surviving spouse or common-law partner (or a qualifying spousal trust), the deemed disposition is not at FMV but at the deceased's Adjusted Cost Base. This means no capital gain is triggered on the death of the first spouse. The tax is deferred until the surviving spouse sells the property or dies. The surviving spouse takes over the original ACB, so the capital gain will be calculated from that point when they eventually dispose of the asset.

• Principal Residence Exemption: A person's principal residence is generally exempt from capital gains tax. If a property qualifies as a principal residence for every year it was owned, the full gain on the deemed disposition is exempt.

• Registered Accounts: Registered accounts like Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) are subject to a different set of rules. At the time of death, the full value of the plan is generally included as income on the deceased's final tax return. However, if a spouse or common-law partner is named as a beneficiary, the funds can be transferred to their own registered plan on a tax-deferred basis.

From the beneficiary's point of view, inheriting an asset is not a taxable event. The beneficiary is considered to have acquired the property at its fair market value at the time of the deceased's death. This "stepped-up" cost base is the starting point for calculating any future capital gains or losses when the beneficiary eventually sells the asset.

For knowledgeable and experienced tax law representation for business succession planning and personal inheritance planning, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

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