When a person dies, all of her property is taxed. This happens because the tax department considers the property to be sold at fair market value on the day the person dies. The difference between the value of the property when the person dies and the original price paid is called the capital gain. The capital gain must be declared to the tax department.
This article talks about some strategies you can use to decrease the taxes your estate will have to pay when you die, or at least postpone them. Some of these strategies might not apply to your situation! It can be a good idea to consult a specialist to get advice on which are suitable for you.
Leave property to your spouse.
If you leave property to your spouse, neither of you will have to pay taxes immediately on the capital gain. The taxable capital gain will be postponed until your spouse sells or gives the property to someone, or until he or she dies. This is called the “spousal rollover.”
This strategy is extremely useful for property with a large capital gain (e.g., cottage, investment property, land, non-registered investment).
If you don’t leave your property to your spouse, the capital gains tax will be due when you die. This tax takes priority and is paid by the estate, which decreases the amount the heirs receive.
For example, you decide to leave your cottage, worth $150,000, to your daughter. You bought the cottage 10 years ago for $50,000. If you die today, your estate must declare a capital gain of $100,000 ($150,000 – $50,000).
Since 50% of the capital gain is taxable, your estate must pay taxes on $50,000, on top of the taxes owing on your other income and capital gains.
How can you leave your property to your spouse? In your will.
Leave your registered retirement savings plan (RRSP) to your spouse.
If you leave your registered retirement savings plan (RRSP) or your registered retirement income fund (RRIF) to your spouse, he or she can transfer the funds to his or her own registered plan when you die. No taxes will be due if no funds are withdrawn.
For example, if you leave your $200,000 RRSP to your wife, she can transfer it to her own RRSP. No taxes will be due until she withdraws money from it.
If you don’t leave your RRSP to your spouse, the taxes on the amounts accumulated will be due when you die. These taxes take priority and are paid by the estate, which decreases the amount the heirs receive.
For example, you leave your $200,000 RRSP to your 26-year-old daughter. When you die, this amount will be added to your income in your final tax return. The only way to avoid taxes is by leaving your RRSP to your spouse.
How can you leave your RRSP to your spouse? In your will.
Leave your registered retirement savings plan (RRSP) to children financially dependent on you.
If you leave your registered retirement savings plan to a child or grandchild who is financially dependent on you, the money can be used to buy an annuity. The child will receive the annuity until the age of 18 An annuity is a set of payments over a fixed period of time. By doing this, you are spreading out the taxes over several years. The tax rate will be lower because people under 18 have low incomes.
If you have a child or grandchild with a physical or mental disability, you can transfer the amounts in your retirement plan to an RRSP or RRIF to the child’s name, or you can buy an annuity for the child. If the child is disabled, the annuity can be paid even after he or she turns 18.
For example, you leave your $90,000 RRSP to your grandson, Simon, who is six years old. You have been taking care of him since your daughter died. Simon will receive an annuity of $7,500 (plus interest) for 12 years. Since this is Simon’s only income, he will pay very little tax.
If you don’t use this strategy, the taxes on the amounts accumulated in your RRSP will be due when you die. These taxes take priority and are paid by the estate, which decreases the amount the heirs receive.
For example, you leave your $90,000 RRSP to your 19-year-old granddaughter Alexia, who is not financially dependent on you. When you die, this amount must be added to your income in your final tax return.
How can you leave your RRSP to children who are financially dependent on you? In your will.
Leave your TFSA to your spouse.
If you leave your tax-free savings account (TFSA) to your spouse, he or she can transfer all or part of the funds to his or her own TFSA before December 31 of the year following your death.
This will not affect your spouse’s own contribution limit. Your spouse must fill out a form called “Designation of an Exempt Contribution – Tax-Free Savings Account (TFSA).” However, the interest earned in your TFSA between the day of your death and the time of the transfer is taxable and must be declared by your spouse.
For example, you leave your $9,000 TFSA to your spouse. The income earned in your TFSA since your death is $150. He can transfer $9,150 to his own TFSA and complete the necessary form before the deadline. He must declare the $150 in his tax return. He can also continue to contribute to his TFSA as if he hadn’t inherited the $9,150. In other words, the amount transferred does not affect his contribution limit.
If you don’t leave your TFSA to your spouse, the income and capital gains from the TFSA will be taxable from the date of your death. However, anything accumulated in the TFSA before your death is not taxable.
How do you leave your TFSA to your spouse? In your will.
Buy life insurance.
Life insurance proceeds go directly to one or more beneficiaries , tax-free.
The beneficiary can be a specific person, or it can be the estate (or the “heirs” or “assigns”).
For example, imagine that you have quite a few debts. You decide to buy life insurance so the proceeds can be used to pay off your debts. You specify that “your heirs” are the beneficiaries of the policy. When you die, the life insurance proceeds can be used to pay off your debts and funeral expenses. Without the life insurance, your executor would have to sell the house or other property or reduce your family’s inheritance.
If you do not have life insurance, your estate might not be able to pay the taxes on your income and capital gains (unless your estate is quite large), not to mention the estate’s other debts. This might affect the size of the bequests.
How do you do this? By buying life insurance and naming one or more beneficiaries in the policy. Usually, you can change the beneficiary at any time without the beneficiary’s permission, unless the designation was “irrevocable”, which means it cannot be changed.
However, divorce or dissolution of a civil union automatically cancels the spouse as a beneficiary, even if it was irrevocable.
Create a trust in your will.
By creating a trust in your will, you can divide the income between the trust and the beneficiaries, who are considered separate taxpayers. This means the income of the trust and the income of the beneficiaries will be taxed separately.
Also, if the trust is created for your spouse only, taxes can be postponed until he or she dies, or until the trust transfers the property received under the will to another person.
For example, you create a trust in your will. You transfer a rental property and your stock portfolio to the trust. Together, they bring in $25,000 a year in rent and dividends. Your spouse and four children are the beneficiaries. You can distribute the income among them through the trust. Each will receive $5,000, and this amount will be added to their income.
If you do not create a trust, the income from the property the estate receives is added to the income of the person receiving it, which increases the taxes due.
For example, you leave your rental property and stock portfolio to one of your children, but you decide not to use a trust.
Your child will have to pay taxes on his or her own income, in addition to the income produced by the property received from the estate. Since his or her income will be higher, the taxes owing will be higher too.
How can you create a trust? In your will.
Give some of your property to your family during your lifetime.
Every time you sell or give certain types of property, you must pay taxes on the capital gain in that year.
However, this decreases the total value of your property, which also decreases the taxes owing upon your death. The taxes will be lower because they are calculated based on a progressive rate structure. “Progressive” means that the rate increases according to the amount of taxable income. By adding these taxable amounts to your current income, instead of waiting until you die, they will be taxed at a lower rate.
Also, by giving property to your family, they will be responsible for any increase in future value, which means that income tax can be postponed until they sell the property themselves, or later, when they die.
Make sure that whatever you give away doesn’t have a negative effect on your lifestyle during retirement.
For example, imagine that you are retired and live in a small house by a lake. You are living well, though modestly, off your RRSPs. While you are still alive, you give the property, worth $100,000, to your two sons. You bought it 10 years ago for $50,000.
The gift of the property to your sons must be declared in your tax return for that year, as if you had sold it. You declare a capital gain of $50,000$ ($100,000-$50,000). Since 50% of the capital gain is taxable, you must pay taxes on $25,000, which will be added to your other taxable income and capital gains for the year. By reducing the total value of your property, you decrease the amount of taxes due when you die.
If you don’t give some of your property to your family members while you are still alive, the capital gain on all of your property must be declared when you die. The more property you have that has increased in value since you bought it, the more taxes will be due when you die.
How do you give property to your family during your lifetime? By following the rules that apply to the type of property (a document prepared by a notary for buildings and property that you are not giving to a family member right away, registration for vehicles, etc.).
Donate to a registered charity.
You can leave money or property to a registered charity when you die. This gives your estate a major tax credit that it can use to reduce the taxes owing.
For example, let’s say that you want to leave some property to your loved ones, but you also want to leave something to “Kind Hearts,” a registered charity that has helped your family.
By giving $1,000$1 to the charity through your will, you will decrease the taxes owing when you die by about $450. The person settling your estate can use this tax savings to reduce the amount of income tax owing. By making this gift, you are supporting the charity of your choice, decreasing the taxes due, and maximizing the inheritance your loved ones will receive.
If you hold securities (e.g., shares, bonds) that are not “registered” (not part of your RRSP), you can also leave them to a registered charity and take advantage of a major tax credit to decrease the taxes owing when you die.
If you don’t donate to a registered charity, your estate can’t take advantage of the charitable donation tax credit.
How do you donate to a registered charity? By identifying in your will the charity you want to donate to. Be sure to include its registration number with the Canada Revenue Agency so that your wishes are carried out.