How is Inheritance Taxed in Canada?

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There is no inheritance tax in Canada, meaning that if you are a beneficiary and receive an inheritance from an estate, then you don’t have to pay any tax on what you receive. Instead, the executor of the deceased’s estate will file a final tax return and pay any taxes required from the deceased’s estate before any distributions are made to beneficiaries. In other words, taxes are paid by the deceased, not their beneficiaries.

However, if you decide to invest your inherited money, or the value of the inheritance increases after you receive it, such as if you earn dividends or interest, you will be taxed on the income you earn. Meanwhile, if you inherit a property and sell it at a value higher than when you inherited it, you may have to pay capital gains tax if you weren’t occupying the home as your principal residence.

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While the beneficiaries are not required to pay any inheritance tax, taxes may need to be paid on behalf of the deceased, which is sometimes referred to as a death tax. The taxes will be paid from the deceased’s estate, which refers to the money and assets owned by the deceased at the time of death.

The taxes are calculated based on the deemed disposition of their assets, the amount in registered investments (such as RRSP and RRIF), and the income they earned up to their death.

All the capital assets in the deceased’s estate, such as property, investments, digital assets, vehicles, etc, are deemed to be disposed of, meaning they are considered to be "sold" at fair market value immediately before death. The deceased is considered to have "received" the proceeds of the sale of all of their assets.

Capital gains or losses are then calculated based on the fair market value of the assets at the time of death and their adjusted cost base, which are then included in the deceased’s final tax return. For example, consider a person holding a publicly traded stock in a non-registered account. If the person passes away on Saturday, then their capital gains will be calculated using the value of the stock at closing on Friday.

Exemptions: There are a few situations where the capital gains tax will not apply:

• Principal Residence Exemption: In Canada, capital gains on the sale of a principal residence are not taxed, which applies in this case too. Capital gains will not apply to the deceased’s primary residence.
• Surviving Spouse: If the deceased has a surviving spouse or common-law partner, and the capital property is transferred to them, no capital gains or losses will be reported on the deceased’s final tax return for this property. Instead, the capital gains taxes are deferred till the beneficiary receiving the capital property will pay capital gains only when they sell the capital property or are deemed to sell it. Thus, the tax payment is deferred till such time.
• Qualified Property: Disposition of qualified property, such as a qualified farm or fishing property (QFFP), or qualified small business corporation shares (QSBCS), may be exempt or partially exempt from capital gains taxes based on the lifetime capital gains deduction limit.

Similar to how all assets are deemed to be disposed of at death, all registered investments, such as RRSPs and RRIFs, are deemed to have been withdrawn at death. Thus, the full amount in these registered plans is considered taxable income for the year of death and needs to be reported on the final tax return.

However, if the deceased has a qualifying survivor (generally spouse, common-law partner or financially dependent child) who has been named as the beneficiary for the registered account, the assets can be transferred to their RRSP, RRIF or eligible annuity. In this case, the estate will not have to pay any tax on this money, and the money will only be taxed when the beneficiary withdraws it.

Any income earned by the deceased person in the year of death, up to the date of death, is also taxable. The income could be from employment, business or even interest income earned on investments. The income must be reported on the deceased’s final tax return.

The executor of the estate will file a final tax return for the year of death. They must include all the capital gains, capital losses, and income on it. Taxes are calculated at the same rates as regular income tax. The executor must also ensure that the CRA is notified of the death and that all taxes owed are paid. Finally, the executor must obtain a clearance certificate before distributing the assets to the beneficiaries.

The final return, or terminal return, is a regular tax package that would normally be for the province or territory of the deceased person's place of residence. The estate will be taxed for any income made during the year of death, from January 1 until the date of death. This would also include the capital gains made on the deemed disposition of assets and deemed withdrawal.

For example, if the deceased were alive and working and passed away on June 30, they would be taxed on their employment income up until that date. These taxes after death will be paid from the estate just like their regular income tax.

If death occurred between January 1 and October 31, the final return is due on April 30 of the following year. If death occurred between November 1 and December 31, the due date is six months after the date of death.

If the deceased person had not filed their previous-year return, which will occur if they die after December 31 but before the filing due date, then the estate would have six months to file the final tax return.

Final Return Due Date (Personal Tax Return)

If the deceased person operated a business, then the due date of the final tax return will differ. If the date of death is between January 1 and December 15, the due date is June 15 of the following year. If the date of death is between December 16 and December 31, then the due date is 6 months after the date of death.

Final Return Due Date (Business)

Filing a final return early: The executor of the estate can also choose to file the final return early, before the applicable tax year. For example, if the deceased person’s date of death was in January 2021, the executor of the estate may choose to file the final return that year in 2021, which means income earned by the deceased during January 2021 will be taxed at 2020 tax rates. If tax rates or tax laws change, the estate may request a reassessment in 2022 to apply the 2021 tax changes to the final return.

Once a final return is filed and taxes are settled, the executor of the estate can request a Clearance Certificate from the CRA. A clearance certificate confirms that the estate has paid all owed taxes based on the information given. However, it does not guarantee that the estate still doesn’t owe any money to the CRA.

The certificate allows the estate's legal representative to distribute assets. If a clearance certificate is not obtained, the legal representative can be personally responsible for taxes and penalties still owed to the CRA.

Probate is the legal procedure for confirming the validity of the deceased’s will and authorizing the appointed executor to act on behalf of the estate. Probate Fees, also known as Estate Administration Tax, are the fees charged by the province for the administration of the probate process. The fees can be a flat rate or a percentage of the estate's assets and vary from province to province. For example, the province of Ontario charges a fee of 1.5% of the value of the estate when for estates valued over $50,000. There is no administration tax for estates valued under $50,000 in the province.

You can reduce probate fees owed to the provincial government by reducing your estate assets while you are alive. For example, naming a beneficiary on investments can ensure the assets are directly transferred to the beneficiary without being taxed as your assets. Co-owning property instead of being the sole owner can also help avoid probate fees.

If the property transferred to the beneficiary were the deceased's principal residence, it would be exempt from capital gains tax. However, all other property would be subject to a capital gains tax, calculated using the value of the property immediately prior to the deceased's death. For the calculation, the executor of the estate can choose to use the property’s

• The fair market value (FMV), or
• The adjusted cost base (ACB).

The estate would pay any applicable capital gains taxes in the final return before the property is inherited at its new adjusted value. However, the executor can only choose to use either the fair market value or the adjusted cost basis at the time of filing the final return. One cannot switch between these two values at a later date.