Receiving an inheritance, whether a family cottage, a portfolio of investments, or simply cash, is a profound experience. While it’s a time for reflection and grieving, it often comes with a jarring financial question: Do I have to pay tax on this money?
It’s a question that brings many Canadians to our office. They are often confused by the difference between an inheritance tax (which Canada doesn’t have) and what the CRA actually taxes at the time of death.
Here’s the truth we share with our clients: Canada does not have an inheritance tax, but that doesn’t mean the assets are transferred tax-free. In fact, a significant and often unexpected tax bill is typically created for the deceased person’s estate before the assets ever reach you.
At Gallo LLP, our Chartered Professional Accountants specialize in guiding executors and beneficiaries through the complexities of estate tax and the pivotal concept of “Deemed Disposition.” We help you cut through the confusion to ensure the estate’s tax burden is legally minimized and your inheritance is protected.
These questions will give you the foundational answers to understand this process and know when to seek professional help.
Does Canada Have An Inheritance Tax?
No! Canada does not impose an inheritance tax.
This means that you, as the person receiving the money or asset (the beneficiary), do not have to report the inherited amount as taxable income on your personal tax return. The cash, jewellery, or investments you receive are generally tax-free in your hands.
However, many people feel like they’re paying an inheritance tax because the tax liability is created at the estate level. The estate must settle all outstanding tax debts with the Canada Revenue Agency (CRA) before any remaining assets can be distributed to the beneficiaries.
In short, the estate pays the tax first, shrinking the inheritance you receive.
If There’s No Inheritance Tax, Why is the Estate Paying Taxes?
The liability comes from a concept called “deemed disposition”, a cornerstone of Canadian tax law regarding death.
Think of it as the CRA’s final review of the deceased’s assets
What is Deemed Disposition?
The Income Tax Act states that immediately before a person’s death, they are “deemed” to have sold (or disposed of) all their capital property at the Fair Market Value (FMV). This is a hypothetical sale; no actual transaction occurs, but for tax purposes, the CRA treats it as if it did.
This rule applies to assets such as:
- Non-registered investments (stocks, mutual funds, bonds)
- Secondary or investment real estate (a rental property or vacation home, such as a cottage)
- Business interests or shares in a private corporation
The Capital Gains Calculation
If the FMV of these assets at the date of the death is greater than their original cost (known as the Adjusted Cost Base), a capital gain is triggered.
The formula works like this:
FMV at Death – Adjusted Cost Base = Capital Gain
Currently, 50% of the Capital Gain is taxable and must be reported as income on the deceased’s Final Tax Return (T1). This can push the deceased’s income into the highest tax brackets for that final year, resulting in a substantial tax bill that the estate must settle.
Who Is Responsible for the Payment?
The estate’s executor (or legal representative) is responsible for filing the deceased’s T1 Final Return and paying all outstanding tax obligations, including the capital gains tax from the deemed disposition.
Only once these taxes (and other debts) are paid can the executor apply for a CRA Clearance Certificate and safely distribute the remaining net assets to the beneficiaries.
The bottom line is clear: the tax is due, and estate pays it first, ultimately reducing the value of the inheritance.
What Assets Are Exempt or Rolled Over?
The good news is that the CRA provides critical exemptions and deferral mechanisms that can significantly reduce the tax liability. These rules are complex, but offer the most powerful planning opportunities.
Exemption 1: The Principal Residence Exemption (PRE)
The most common tax break at death is for the primary family home:
- The Rule: A deceased person’s primary residence (the home they ordinarily inhabited) is exempt from capital gains tax for every year it qualifies. This tax benefit is available to the estate and must be officially claimed on the deceased’s final tax return
- The Nuance: The exemption only applies to one property per family unit per year. If the deceased owned a second property (like a rental or vacation property), the executor must decide which property receives the PRE for each year of the ownership to minimize the total tax bill. This calculation is a key area where a CPA’s expertise is essential
Exemption 2: The Spousal Rollover
This rule is designed to protect the surviving spouse or common-law partner from immediate taxation:
- The Rule: Assets that pass directly to a surviving spouse or common-law partner (or a qualifying spousal trust) are transferred on a tax-deferred basis
- The Deferral: Instead of being “sold” at Fair Market Value (FMV), the property is deemed to be transferred at its Adjusted Cost Base (ACB) (original cost). This means no capital gain is triggered on the deceased’s final tax return, and the tax liability is deferred until the surviving spouse eventually sells the asset or passes away
- Key Insight: This rollover is often automatic, but in some strategic planning cases (if the deceased had significant carried-forward capital losses or wanted to utilize the Lifetime Capital Gains Exemption), the executor can elect to opt out of the rollover for specific assets. This requires careful professional analysis
Other Tax-Advantaged Assets
- Tax-Free Savings Account (TFSAs): Assets inside a TFSA are generally not taxed at death and pass to the named beneficiary (or the estate) tax-free
- Life Insurance: Proceeds from a life insurance policy are paid to the named beneficiary tax-free and often bypass both the estate’s taxes and provincial probate fees, providing the estate with the necessary cash to cover any outstanding tax liabilities
I Inherited A Cottage, Will I Pay Capital Gains Tax When I Sell It?
You, the beneficiary, generally will not pay any tax upon the inheritance itself. However, you will pay capital gains tax if you sell the asset for a profit in the future.
The Stepped Up Cost Base
This is a key concept that benefits you:
- The asset’s original cost base for the deceased is irrelevant to you.
- Your new starting cost (your Adjusted Cost Base or ACB) is “stepped up” to the asset’s Fair Market Value (FMV) on the date you inherited it.
Here’s what that means for you:
Your future Capital Gains tax will only be calculated on any increase in value from the date of inheritance to the date you eventually sell the property.
Sale Price − FMV at Inheritance (Your New ACB) = Future Capital Gain
An accurate professional appraisal of the asset’s FMV on the date of death is critical. If the FMV is understated, the estate’s tax bill is lower, but your future tax bill upon sale will be higher.
A CPA ensures this key valuation is handled correctly to achieve the best overall tax result for the family.
Protecting Your Inheritance: The Gallo LLP Advantage
Navigating the estate administration process, the Deemed Disposition rules, and the various exemptions is highly complex. Executors face personal liability if they distribute assets without first satisfying the CRA’s demands.
Our Gallo LLP team does more than file taxes; they act as a strategic partner to protect the legacy being passed down. We help by:
- Maximizing Deferrals: Strategically applying the Spousal Rollover or other exemptions to legally minimize the tax owed on the deceased’s final return
- Executor Guidance: Guiding the executor through the multiple returns required (T1 Final, T3 Trust) and ensuring the critical CRA Clearance Certificate is obtained before any distribution
- Setting the Future Cost Base: Working with appraisers to accurately establish the FMV on the date of death, which is the foundational figure for all future capital gains calculations for the beneficiaries
- Advising on Business Succession: For business owners, we develop tax-efficient succession plans that use tools like the Lifetime Capital Gains Exemption to minimize the tax hit on transferring shares
- Managing Cross-Border Assets: Providing specialized advice for estates that include U.S.-based assets (like vacation homes or investments), which can be subject to U.S. estate tax
- Creating Liquidity Strategies: Integrating assets like life insurance into the plan to ensure the estate has enough cash to pay the tax bill without being forced to sell treasured assets (like the family cottage)
Don’t leave the value of your legacy to chance. Proactive planning and expert advice are the only ways to protect the wealth you intend to pass on!