Unlike the U.S., Canada no longer has any form of estate or inheritance tax. Yet despite this, death can trigger a significant income tax bill that, if not properly planned for, can leave an unexpected liability when a loved one passes away. Here is what happens to your non-registered and registered assets when you die:
The general rule for non-registered assets is that a taxpayer... is deemed to have disposed of all his or her property, such as stocks, bonds, mutual funds and real estate immediately before death at their fair market value (FMV).
When the FMV exceeds the property’s adjusted cost base (ACB), the result is a capital gain, half of which is taxable to the deceased and must be reported in the deceased’s final tax return, known as the “terminal return.” There is an exception for the capital gain arising on the deemed disposition upon death of your principal residence, which is generally exempt.
For example, let’s say you die with a portfolio worth $10,000 that had an ACB of $4000. The capital gain on the deemed disposition at death would be $6000. Since only half the gain is taxable, tax would be owing on a $3000 taxable gain. Assuming a 30% marginal tax rate for the year of death, $900 of taxes would be payable on the terminal return as a result of this deemed disposition.
For many Canadians, however, the largest tax liability their estate will face is the potential tax on the FMV of their RRSP or RRIF upon death. The tax rules require the FMV of the RRSP or RRIF as of the date of death to be included on the deceased’s terminal tax return with tax payable at the deceased taxpayer’s marginal tax rate for the year of death.
This income inclusion can be deferred if the RRSP or RRIF is left to a surviving spouse or partner, in which case tax will be payable by the survivor at his or her marginal tax rate in the year in which funds are withdrawn from the RRSP or RRIF.
Alternatively, an RRSP or RRIF may be left to a financially dependent child or grandchild and used to purchase a registered annuity that must end by the time they reache age 18. The benefit of doing this is to spread the tax on the RRSP or RRIF proceeds over several years, allowing the child or grandchild to take advantage of personal tax credits as well as graduated marginal tax rates each year until he or she reaches the age of 18. If the financially dependent child or grandchild was dependent on the deceased because of physical or mental disability, then the RRSP or RRIF proceeds can be rolled to the their own RRSP or RRIF.