According to Canadian tax law, a taxpayer is deemed to have disposed of all of their property at the fair market value, immediately before death, even though a sale of assets did not take place. This could include non registered assets, RRSPs/RRIFs, real estate, cars, investments, shares in a private company, etc. Deemed disposition triggers capital gains and burdens the estate with a potential tax liability that they’d have to be responsible for.
A terminal tax return must be filed by the executor in order to account for this deemed disposition and the tax payable that’s triggered. However, you may defer the tax through:
- Rollover Provisions – By registering your assets in joint a, naming a qualifying beneficiary on your registered investments or transferring assets into a spousal trust, you can limit the impact of deemed disposition.
- Exemptions – By taking advantage of tax planning tools such as Lifetime Capital Gains Exemption, you can limit the impact of deemed disposition.
- Tax Elections – By contributing into a spousal RRSP, splitting income, filing additional tax returns and using capital losses, you can limit your tax liability.
Due Date of Final Tax Return
Individual
- If the death of the taxpayer occurred between January 1st and October 31st, final return is due on April 30th of next year.
- If the death occurs later in the year between November 1st to December 31st, the final tax return is due within 6 months.
Business Owner
If the deceased was running a business at time of death, the deadline to file a tax return is as follows:
- If the death of the taxpayer occurred between January 1st and December 15th, final return is due by June 15th of next year.
- If the death occurs later in the year between December 16th to December 31st, the final tax return is due within 6 months.
Spousal Trust
If upon death a spousal trust is set up through a deceased’s will, then final due date of the tax return is 18 months after the date of death. Any taxes payable is due by due date mentioned above.
It's important to file the final return on time as CRA charges a penalty of 5% on any taxes owing plus 1% of the balance outstanding for each full month, up to a maximum of 12 months.
T1 Terminal Tax Return
The T1 return also known as the final return would include the taxpayer’s income from January 1st up to the date of death. This would include investment and employment income in addition to any accrued amounts. Due to deemed disposition, you would also have to include, dividends, interests as well as the fair market value of all RRSPs/RRIFs in the final income.
Deemed Disposition of RRSPs/RRIFs
At the time of death, a taxpayer is deemed to have received the fair market value of their RRSP/RRIF as income which is to be taxed at their marginal tax rate. However, there are exceptions to this as tax can be deferred by naming a qualifying beneficiary such as your spouse or dependent child. In Quebec, a beneficiary must be named through your will.
- Naming Your Spouse as a Beneficiary – Upon death, your RRSP/RRIF investments will be liquidated and the spouse may transfer the funds directly into their own RRSP or RRIF on a tax deferred rollover. However, depending on your tax situation, such as low income during the year of death, it could be beneficial to have the proceeds be taxed on your final tax return or in your spouse’s hands in order to minimize your tax payable.
- Naming Your Spouse as a Successor Annuitant – Successor annuitant applies to your RRIF and upon death, the RRIF will continue to exist in your wife’s name. As a successor annuitant, your spouse can control the timing of withdrawals and taxation.
- Naming a Dependent Child as a Beneficiary – Upon death, the value of your RRSP/RRIF can be taxed in your hands or the beneficiary’s hands on the final tax return which is advantageous as they would be more to likely have minimal income.
RRSP Deduction
In the final year of death, if the deceased taxpayer has contribution room, the executor can make a contribution into a spousal RRSP. This will result in a tax deduction on the final return of the deceased and minimize the impact of deemed disposition.
In addition to the final return, there are 3 optional tax returns that can be filed on behalf of the deceased individual which can reduce the tax payable. By filing optional tax returns, the deceased can claim personal tax returns credits more than once. This could result in tax savings for the estate. These optional tax returns are:
- Testamentary Trust – If the deceased received income from a testamentary trust, the income can be reported on a separate tax return.
- A business where the deceased was a partner in – income from a business that the deceased taxpayer was a partner in can be reported in a separate tax return.
- “Rights and Things” – includes income that the deceased taxpayer was entitled to but was not paid at the time of death. This could include things such as OAS payments, bond interest, accounts receivables, dividends, vacation pay, CPP, bonuses, etc.
Deemed Disposition of Property
Just before death of a taxpayer, they’re deemed to have sold all of their property at Fair Market Value (FMV) even though no actual sale took place. This is known as deemed disposition. This could include your home, cottage, securities, land, buildings, equipment, etc. This deemed disposition would trigger capital gains or a capital loss.
A capital gain means that the deemed proceeds of the property was higher then what they purchased it for, known at the Adjusted Cost Base (ACB). According to the Income Tax Act, only 50% of the increase of profits would be taxed at the deceased marginal tax rate.
However, if the deceased was married or had a common law partner, the capital property can be rollover in their name at the Adjusted Cost Base or Fair Market Value. Rolling the property over at the adjusted cost base (ACB) will result in a tax deferral and limit deemed disposition. Keep in mind that when the assets are sold in the future, a tax liability will be triggered in which the spouse would be responsible for. Depending on your tax obligations, individuals may also rollover the property at the FMV. Below are scenarios where it would make sense doing so.
Transferring Capital Property at Fair Market Value
- You Have Capital Losses from Prior Years – It would be beneficial to transfer property to the spouse at FMV in the year of death, if the deceased had capital losses in prior years. If so, the deceased’s estate would be able to deduct capital losses against capital gains. Depending on the property, the capital losses would offset any gains thus resulting in no tax payable.
- Taking Advantage of Lifetime Capital Gains Exemption – If the deceased owned a Qualified Small Business Corporation (QSBC) or a qualified fishing or farming property with unrealized gains then they could transfer the property at the FMV and take advantage of the Lifetime Capital Gains Exemption (LCGE). As of 2019, the exemption is $866,912. Since only 50% of the capital gains from disposition is included in your taxable income, the allowable tax deduction is $433,456.
- Property with Accrued Loss – Capital losses can be only used to offset capital gains but special tax rules apply during time of death. The deceased’s estate may be able to deduct any excess net capital losses accrued against other sources of income on the final tax return or in prior year. By doing so, they can reduce the tax payable that would be trigger by transferring the property at FMV.
Deemed disposition can cost you and your family in thousands of dollars in tax bills. It’s important to be vigilant and prepared when the unfortunate happens. By following the simple steps above, your family can limit the impact of deemed disposition and use that money towards better the life of the next generation.