Tax Implications of Inherited Money or Property
Inheriting money or property can be a mixed bag. While it’s a windfall, it also comes with a whole lot of tax implications that can be overwhelming. Understanding Canadian inheritance tax laws and the stance of the Canada Revenue Agency is key to managing your inheritance well and being tax compliant in Canada.
Inheritance Tax in Canada
The good news is Canada doesn’t have an inheritance tax. However, it is important to understand the nuances of inheritance taxes and estate taxes, especially when dealing with cross-border inheritances and the implications for Canadian residents. But that doesn’t mean inherited money or property is tax free. The estate is taxed before the assets are distributed to the beneficiaries.
Tax Implications for the Deceased’s Estate
Deemed Disposition
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Upon death, the deceased is deemed to have disposed of all their assets at fair market value immediately before death. This can result in capital gains or losses and taxes payable by the estate.
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Capital Gains Tax: Any increase in value of the deceased’s assets since they were purchased is subject to capital gains tax. The estate must report these gains on the deceased’s final tax return.
RRSPs and RRIFs
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Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) are fully taxable upon death unless rolled over to a surviving spouse or dependent child.
Principal Residence Exemption
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Sale of the principal residence is tax free, but the exemption must be claimed on the final tax return.
Inherited Property and Capital Gains Tax
When you inherit property, you get it at its fair market value at the time of death. Here’s what you need to know:
Probate fees are separate from inheritance tax and are charged by provinces on the value of the estate being transferred. The rates vary across provinces.
Primary Residence
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If you inherit a primary residence and live in it, you won’t pay tax until you sell it. At that point, capital gains tax will apply based on the increase in value from the time of inheritance to the sale.
Rental Property
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Inherited rental property will generate rental income which is taxable. You’ll need to report this income on your tax return and can deduct expenses related to the property.
Selling Inherited Property
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When you sell inherited property, you’ll pay capital gains tax on the increase in value from the time you inherited it to the time you sold it.
Inherited Money
Cash Inheritance
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Cash inheritances are tax free in Canada and are generally not considered taxable income. But any income generated from the inherited cash, such as interest or dividends, is taxable.
Investments
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If you inherit investments like stocks or mutual funds, you get them at fair market value. When you sell these investments, you’ll need to report any capital gains or losses.
Strategies to Minimize Tax on Inherited Assets
Principal Residence Exemption
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If you inherit a property that’s a principal residence, consider designating it as such to claim the capital gains tax exemption.
Rollover Options
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For RRSPs and RRIFs, rolling over to a spouse, common law partner, or dependent child can defer tax payments.
Tax-Efficient Investments
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Invest inherited money in tax-advantaged accounts like TFSAs or RRSPs to minimize taxes on future income.
Gifting During Lifetime
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To reduce the tax burden on your estate, consider gifting assets during your lifetime. This can lower the value of your estate and potentially reduce taxes.
Real-Life Example: Inheriting Property in Toronto
Sarah inherits her mother’s home in Toronto. Here’s how she handles the tax:
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Fair Market Value: She gets the home valued at $800,000.
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Capital Gains: If she sells it 5 years later for $900,000, she’ll pay capital gains tax on the $100,000 increase.
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Primary Residence: If Sarah lives in the home and designates it as her primary residence, she can claim the principal residence exemption when she sells it and avoid capital gains tax.
If Sarah were a surviving spouse or common-law partner, the assets could be transferred on a tax-deferred basis, allowing the deferral of taxes until she sells the asset or passes away.
FAQs on Inherited Money or Property
Q: Do I have to pay tax on money I inherit from a deceased relative?
A: No, cash inheritances are tax free in Canada. The Canada Revenue Agency does not consider inherited money and personal items as taxable income because the estate has already paid taxes. However, any income generated from investing the inherited cash is taxable.
Q: If I inherit a house and sell it immediately?
A: You’ll pay capital gains tax on the increase in value from the time of inheritance to the sale.
Q: Can I defer taxes on inherited RRSPs?
A: Yes, you can defer taxes by rolling over inherited RRSPs to a spouse or dependent child.
Q: What expenses can I deduct if I inherit a rental property?
A: You can deduct expenses related to the property, such as repairs, maintenance, property taxes and mortgage interest.
Q: How can I reduce the tax burden on my estate?
A: Consider gifting during your lifetime, use the principal residence exemption and invest in tax-advantaged accounts.
Conclusion: Tax Maze
Inheriting money or property can have a big impact on your finances. Knowing the tax implications will help you make informed decisions and get the most out of your inheritance. Plan ahead and get professional advice to navigate the inherited assets and keep more of your money.
Contact a tax accountant for personalized advice on your inheritance.
Inheriting assets can be tricky but with the right tax planning and advice, you can navigate the tax and get the most. Get in touch and we will give you the tax tips!