Canada's Inheritance Tax Rules

Updated March 2019

Canada had an inheritance tax until 1972. Since then, any money acquired via inheritance is seen as capital gain and taxed accordingly. But, things could change again.

Read on for an overview of inheritance tax in Canada.

How much can you inherit before paying inheritance tax?

Whether or not you pay taxes on an inheritance depends on whether or not it constitutes a capital gain. For tax purposes, when someone dies, the value of their property is evaluated at fair-market value. This estimated amount is called the deemed proceeds of disposition.

Deemed proceeds may constitute a capital gain or a capital loss. The proceeds or deemed proceeds of depreciable property or personal-use property cannot be claimed as a capital loss. With depreciable property, there may be a recapture of capital cost allowance or a terminal loss.

Recapture of capital cost allowance is based on undepreciated capital cost (UCC). This is the balance of capital cost subject to further depreciation at any time. The amount of CCA you claim each year will lower the UCC of the property.

A recapture of CCA is when the proceeds or deemed proceeds of disposition exceed the UCC. That amount is treated as taxable income.

A terminal loss is when the proceeds or deemed proceeds of disposition are less than the UCC. That amount can be deducted from income on the tax return.

Recapture of CCA and terminal loss

Example: A piece of machinery costs $10,000. The UCC for its capital cost allowance class is $6,000.

If the owner sells the machine for $4,000:

• No capital gain
• Subtract CCA claimed in previous years
• Subtract $4,000 -- the lesser of the proceeds of disposition minus related outlays and expenses; or the capital cost of the property -- from UCC of $6,000
• Result is a terminal loss of $2,000 ($6,000 - $4,000), deductible from business income

If the owner sells the machine for $8,000:

• Because it's still less than the original cost, no capital gain
• Subtract $8,000 (the lesser of the proceeds of disposition minus related outlays and expenses; or the capital cost) from UCC of $6,000
• The result is a recapture of CCA of $2,000 ($6,000 - $8,000) that must be included in business income

If the owner sells the machine for $12,000:

• Capital gain of $2,000 (since the original capital cost was $10,000)
• Subtract $10,000 (the lesser amount) from UCC of $6,000
• The result is a recapture of CCA of $4,000 ($6,000 - $10,000) that must be included in business income

You can find more information about recapture and terminal loss in the CRA document Income Tax Folio S3-F4-C1, Discussion of Capital Cost Allowance.

Rules on inherited property

Chapter 4, "Deemed disposition of property," in the CRA's Guide T4011, Preparing Tax Returns for Deceased Persons 2017, outlines current rules for inherited property. These rules apply only to property acquired after December 31, 1971. For information about a property that a deceased person owned before 1972, or about resource property or an inventory of land, call the CRA at 1-800-959-8281.

As mentioned above, the deemed proceeds of disposition apply to the value of an estate even if no sale of the property has taken place. Heirs are responsible for paying applicable taxes on certain capital gains.

A capital gain is when the proceeds or deemed proceeds of disposition of capital property are more than its adjusted cost base. The adjusted cost base (ACB) is the cost of a property, plus any expenses incurred in its acquisition, such as commissions and legal fees.

In general, you have to pay tax on one-half of the capital gain. See below for information on the capital gains deduction.

A capital loss is when the proceeds or deemed proceeds of disposition of a capital property are less than its adjusted cost base. You can claim one-half of a capital loss. Recall that with personal-use and depreciable property, you cannot claim a capital loss.

Claiming capital losses in the year of death

There are two ways to apply a net capital loss incurred in the year of death.

Method A: Carry back a net capital loss to reduce any taxable gains in any of the three years prior to the year of death. In 2017, no further adjustment would have been necessary because the inclusion rate was the same in 2014, 2015 and 2016.

Fill out "Section III - Net capital loss for carryback" on Form T1A, Request for Loss Carryback and send it to your tax centre to apply. Do not file an amended return.

An amount left over after the carryback might be used to reduce other income on the final return, the return for the year before the death, or both.

Subtract any capital gains deductions the deceased has claimed to date from the remaining net capital loss. You can then use this amount to reduce other income for the year of death, the year prior, or both.

To claim the remaining capital loss in the year of death, enter it as a negative amount in brackets on line 127 of the final return.

Method B: Instead of using the remaining net capital loss to reduce income from capital gains, you can use it to reduce other income for the year of death, the year prior, or both.

As with Method A, subtract any capital gains deductions the deceased has claimed to date from the net capital loss. Enter the difference as a negative amount in brackets on line 127 of the final return.

What are the inheritance tax changes in 2018?

The July 2018 report Born to Win: Wealth Concentration in Canada since 1999 from the Canadian Centre for Policy Alternatives addresses the disparity in wealth between Canada's wealthiest families and the rest of the population. Written by CCPA economist David Macdonald, it recommends an inheritance tax to help level the playing field.

"Canada's wealthiest 87 families have 4,448 times more wealth than the average Canadian family." Macdonald observes. "Canada could remedy this situation with tax reforms aimed at reducing inequality Instituting a 45% estate tax on estates valued over $5 million, in line with the rest of the G7, would add $2 billion to federal revenue."

However, inheritance tax in other G7 nations has done little to reduce income disparity. Harvard economist Greg Mankiw argues that eliminating all inheritance tax, while creating a universal sales tax, would be better for everyone in the long run.

Macdonald's report has sparked much debate, but his suggested reforms haven't ignited any implementation in Canada.

Can you avoid inheritance tax?

You can avoid or reduce some taxes on an inherited property through certain types of deductions. Some capital gains may even be tax-free.

Capital gains deduction

You might be able to claim a deduction for a deceased person's eligible taxable capital gains from the disposition or deemed disposition of some types of capital property.

The capital gains deduction might apply if the deceased had taxable capital gains from:

• Dispositions or deemed dispositions of qualified farm or fishing property
• Dispositions or deemed dispositions of qualified small business corporation (SBC) shares
• A reserve brought into income from either of the above

For 2018, the lifetime capital gains exemption for dispositions of qualified SBC shares is $848,252. The inclusion rate for capital gains and losses is 50%, so the deduction limit for 2018 for dispositions of QSBC shares is $242,126.

The lifetime capital gains exemption for qualified farm or fishing property is $1,000,000. With the inclusion rate for capital gains and losses of 50%, the lifetime capital gains deduction limit is $500,000.

Check out the CRA Guide T4037, Capital Gains for further information.

Net capital losses before the year of death

If the deceased incurred a net capital loss before the year of death but never applied it, you can apply it against taxable capital gains on the final return. For net capital losses incurred after 1987 and before 2001, you will need to adjust for the inclusion rate.

Apply any leftover amount to reduce other income on the final return, the previous year's return, or both. This loss is reported on line 253.

Before you can apply a previous year's net capital loss against your current-year capital gains, you have to apply it to the year it took place. For example, you would apply a 1997 net capital loss against that year's capital gain, then apply your 1999 net capital loss, and so on.

The inclusion rate for 2018 was one-half. To apply a previous year's loss to 2018, you might use different inclusion rates:

• For a net capital loss from 1987 or earlier: no adjustment required
• For a net capital loss from 1988 or 1989: multiply the loss by 3/4
• In the case of a net capital loss from 1990 to 1999: multiply the loss by 2/3
• For a net capital loss from 2001 or later: no adjustment required

Calculating net capital loss

A net capital loss incurred in 2000 is calculated differently. Find the inclusion rate on line 16 of Part 4 of the deceased's Schedule 3 from 2000, or from the deceased's notice of reassessment. Multiply the loss by [1 √∑ (2 x IR)], where IR is the inclusion rate.

These calculations will give you the adjusted net capital loss.

To reduce taxable gains in the year of death, apply the lower of either the adjusted net capital loss or taxable gains in the year of death.

If, after reducing taxable capital gains, there is still some loss left, use this amount to reduce other income for the year of death, the previous year, or both.

If you had to adjust the loss for a previous year's inclusion rate, you will have to readjust what the remainder of the loss, as follows:

• For a net capital loss from 1987 or earlier: no adjustment required
• For an adjusted net capital loss from 1988 or 1989: multiply by 3/4
• In the case of an adjusted net capital loss from 1990 to 1999: multiply by 2/3
• For an adjusted net capital loss from 2000: multiply by (2 x IR)
• For a net capital loss from 2001 or later: no adjustment required

These calculations will give you your readjusted balance of net capital losses. You can subtract from this balance all capital gains deductions claimed to date, including those on the final return. Any remaining amount is used to reduce income for the year of death, the previous year, or both.

Seek professional help

Canada's inheritance tax laws are intricate and complicated. It can be a lot to handle without a legal representative. Inquire at your financial institution or local tax service office for professional advice.