Capital gains tax is the tax paid on the increase in value of certain assets known as capital property. The type of capital property dealt with by executors most often is real estate, though other assets such as the shares of a privately-owned corporation are also capital property.
Capital gains tax works like this. On the day you first acquire an asset, it has a value (called the adjusted cost base). If we are dealing with real estate, the value is normally the price you paid for the property. Over the time that you own that property, it gains in value. The longer you own it, the more likely that the value will increase. On the day you get rid of the asset - by selling it or transferring it under your Will when you die - it therefore has a greater value than it did when you got it. The difference between the value on the day you got it and the value on the day you dispose of it is known as the capital gain. You have to pay tax on one-half of that increase in value.
As an example, let's say Leia buys a house for $150,000. She owns it for many years and when she dies, her executor is going to sell the house. Now it's worth $550,000. The capital gain on the property is $400,000. Leia's estate has to pay tax on half, or $200,000. This doesn't mean that there is $200,000 in tax owing. It means that $200,000 is added to income for that year on the tax return, and the executor will use as many tax deductions, exemptions etc as he or she can to reduce how much tax must be paid.
If the property was worth less at the date of her death than it was when Leia acquired it, she would instead have a capital loss that she could apply to her return.
This is triggered by Leia's death because in law you are deemed to have sold everything you own one minute before you died. This means that even if your executor is not selling the house but is transferring it to a beneficiary, you are still deemed in law to have sold it at fair market value.
There are some exemptions to the rule about capital gains. The one that is important to most executors is that a person does not have to pay capital gains tax when he or she disposes of his or her principal residence. So if the house Leia owned was her principal residence, the $200,000 would not have to be added to her income.
On the other hand, if the house Leia owned was a summer cottage or a rental property, the tax would be owing.
Your principal residence doesn't necessarily have to be the house you live in most of the time. If you happen to own another house that is worth more, you could designate that more expensive one as your principal residence (don't do this without talking it over with your accountant first!).
A married couple only gets one principal residence between them.
Before taking any steps to avoid capital gains tax by setting up trusts or joint ownership or other ideas, you absolutely must speak with an accountant or estate planning specialist about your specific situation. Often people set up schemes to avoid one thing but they haven't looked at the whole tax picture, such as potential tax hits when a property is transferred from an individual to a trust or to joint owners. There may also be other tax solutions available that you hadn't thought of.
More of a question than a comment really. My dad's brother is the executor of his estate and is claiming that we will need to pay capital gains on the condo dad lived in when it sells. After reading the above I no longer think that's true. Is it? My dad also bought his sister's condo in my & my 2 brothers names in order to help her out. Two of us own homes but the third does not. Eventhough my aunt lives there free of charge, we would need to pay capital gains on this property when we sell it, correct? How long would one of us have to live in this condo as a principal residence in order to avoid capital gains tax?
ReplyDeleteIf it was your Dad's principal residence, no capital gains have to be paid and there is no inheritance tax in Canada.
DeleteRe. the second condo which the Aunt lives in, the person who does not have a home yet could designate this as his principal residence (review the designation on principal residences forms to make sure it applies)and no tax would be payable on sale by him but if you are owners in common (not joint), the other two may have to pay capital gains on two thirds of the gain. You should keep track of the purchase documents of your Dad to establish the cost plus all the taxes and legal costs which are part of the adjusted cost.
Great blog. My mom just asked me to try to figure out if she could move into her rental property to try to avoid taxes. I told her she needs to talk to an accountant but of course she didn't take my word for it! Thanks for the post!
ReplyDeleteHi Andrew,
ReplyDeleteYou're welcome and you're absolutely right that your mom needs to talk to an accountant before making an important move like that.
Lynne
Hi,
ReplyDeletelet me first appreciate for this very helpful blog. My husband passed away(at age 35) 50 days ago and we didn`t still havechildren. there is a house under his name which we used to live in and a house of mine( revenue prperty). His parents pushing me for give them their 1/3. I would like to know I have to pay capital gain tax on both propert? or principal residence which is under his name will be excluded? how about the propert which is under my name and will be include in seccession! Do I need to pay capital gain tax on this one? Thanks for your response.