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 on Death. This could include your home, cottage, securities, land, buildings, equipment, etc. This would trigger capital gains or a capital loss. Deemed disposition on death can lead to thousands of dollars in final tax bills if you’re not prepared. One of the best ways to lower this tax bill is to minimize the probate fees.
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. 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 and limit the consequences that may arise from deemed disposition.
Deemed Disposition on Death -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 on Death – Avoiding Probate Fees
We know that deemed disposition means that you have sold all of your assets immediately upon death which could lead to a tax bill for your estate. In addition, keep in mind the probate fees that your estate may be responsible for. Probate is the legal process where will goes through provincial courts in order to get certified and validated. This process can be expensive but there are ways to avoid probate and minimize your estate tax arising from deemed disposition on death.
- Naming Beneficiaries on Registered Investments such as RRSPs, TFSA, RRIFs, SRSP, LIF, LIRA
- By naming a beneficiary on your registered investment, you’ll be able to avoid probate fees as upon your death, the funds would be transferred to your spouse or a qualified beneficiary. Naming beneficiaries is one of the easiest way to lower your tax bill due to deemed disposition on death.
- Naming Beneficiaries on Insurance Policies and Segregated Fund Policies
- By naming a beneficiary on your life insurance policy, the death benefit would be paid directly to the beneficiary, thus by-passing the estate and probate.
- Registering Property in Joint Ownership
- Property registered in joint would pass to the spouse upon the other’s death. This could include real estate, bank accounts, joint ventures, etc. Registering property in joint is a great way to limit probate fees and lower taxes arising from deemed disposition on death.
- Excluding assets into the estate by using trusts
- One can avoid probate by transferring property into a living trust, also known as an inter-vivos trust. The property transferred into the trust belongs to the trust for the benefit of the beneficiaries. Once the trustee passes away, the successor trustee would be able to manage the assets.
- Gifting property, assets and investments
- You can gift assets or property so it belongs to someone else. Doing so will exclude the asset from your estate and not be subject to probate.
- Estate Freeze
- One may freeze the value of their estate by limiting the growth of capital assets such as real estate, securities, corporate interests etc. Doing so, you would be transferring any future growth of the assets to another party, usually your family members.
The bottom line is that deemed disposition on death can be expensive if you’ve not prepared. Speak to your lawyer and financial advisor on ways to limit your estate tax.
