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Thursday, August 11, 2011

How much inheritance tax do I pay in Canada?

I continue to receive dozens of questions about inheritance tax, so clearly this is a topic that needs to be mentioned in this blog more often. Most of the time, the question appears to be from an individual who is inheriting something (as opposed to an executor or someone planning their own estate) so I'll concentrate on that perspective today.

The good news is that if you are a Canadian resident and inherit something from a Candian estate, you don't have to add anything to your tax return. You aren't taxed on what you receive.

This is not to say that the estate won't have to pay any taxes before it releases your inheritance to you. You could inherit less from the estate because tax has to be paid by the estate. For example, you and your brother are the only beneficiaries of your parents' estate. The estate includes, among other things, a house and a cottage. There is no tax on the transfer of the house but there IS capital gains tax on the transfer of the cottage. The estate has to pay that tax, not you. Debts have to be paid before beneficiaries can be paid. So if other assets in the estate such as the savings account are used to pay the cottage taxes, there is less in the estate to give to you and your brother.

Having said all of that, if the will specifically says that you as a beneficiary are to pay the taxes on a certain asset, then you will have to pay them to receive the asset, rather than the estate pay them. This is pretty rare, but certainly happens from time to time.

A mistake that some beneficiaries make is to believe that the house they inherit from their parents is "tax free" and always will be no matter what they do. They think this because they inherited it without having to pay tax, and without the estate having to pay tax. However, when the beneficiary later decides to sell the house, he or she could well have to pay tax at that point.

For example, you inherit the house from your parents, which is valued at $300,000. You get that tax-free. You already live in your own home, which is your principal residence. A couple of years later you decide that you really don't want to hold on to your parents' home any longer, so you sell it for $350,000. Because your parent's home is not your principal residence, you have to pay tax on the increase in value. The increase was $50,000, so you would have to add half of that, or $25,000, to your income tax return as income in the year you sold the house.

Please note that I'm simplifying the general rules here for the purpose of illustration, and an accountant can give you much more detailed information on your specific situation.

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