Is There Capital Gains on Inherited Property in Canada?

Tax Implications on Inherited Real Estate

Receiving property from a loved one is often an emotional experience. Amidst the personal responsibilities, you must also consider the financial implications. Some beneficiaries wonder if there capital gains on inherited property in Canada? The answer is not a simple yes or no. The tax event does not typically happen when you, the beneficiary, receive the property. Instead, the tax liability is usually handled by the deceased person’s estate before the asset ever transfers to you. This process involves a critical concept called “deemed disposition,” which treats the property as if it were sold just before the owner’s death.

This rule ensures that any increase in the property’s value during the deceased’s lifetime is taxed. The estate is responsible for reporting this gain and paying the associated tax on the deceased’s final tax return. Understanding this distinction is the first step in managing an inherited property. It separates the estate’s tax duties from your future responsibilities as the new owner. Your financial journey with the property begins after this initial tax step is complete.

How Deemed Disposition Works at Death

The Canada Revenue Agency (CRA) has a specific rule for capital property when someone passes away. This rule is called “deemed disposition.” The CRA considers the deceased person to have sold all their capital property, including real estate, for its fair market value (FMV) immediately before their death. This “pretend” sale creates a capital gain or a capital loss for the deceased’s estate. The estate’s executor or representative must calculate this gain or loss and report it on the deceased’s final income tax return. This is the moment the government taxes the property’s appreciation in value.

Let’s use an example. Imagine your parent bought a cottage for $100,000 years ago. At the time of their passing, the cottage has a fair market value of $600,000. The deemed disposition results in a capital gain of $500,000 ($600,000 FMV minus $100,000 original cost). In Canada, 50% of a capital gain is taxable. Therefore, $250,000 is added to the deceased’s income on their final tax return. The estate must pay the income tax on this amount. This entire process happens before you officially inherit the cottage. It settles the tax obligations from the deceased’s ownership period.

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Related Article: Do I Have to Pay Taxes on a House I Inherited in Canada?

Your Tax Responsibility When You Sell

Once the estate settles any taxes and you inherit the property, your own tax story begins. The property’s value at the time you inherit it becomes your new cost base. This is known as the Adjusted Cost Base (ACB). For tax purposes, it is as if you purchased the property for its fair market value on the date of the original owner’s death. This is a crucial point. You are not responsible for the appreciation in value that occurred before you inherited it; the estate already handled that through the deemed disposition process.

Your capital gains calculation starts from this new ACB. For example, if you inherit a cabin with a fair market value of $400,000, your ACB is $400,000. If you hold onto the cabin for a few years and its value increases, you will have a capital gain when you decide to sell. If you sell it for $450,000, your capital gain is $50,000 ($450,000 sale price minus your $400,000 ACB). You would then report this on your personal income tax return for the year of the sale. You will pay tax on 50% of that gain, which is $25,000.

• Determine Your Adjusted Cost Base (ACB)

  Your ACB is the fair market value of the property at the time of the previous owner’s death. You need an official appraisal to establish this value.

• Track Future Expenses

  Keep records of any capital improvements you make to the property, like a new roof or a kitchen renovation. These costs can be added to your ACB, which reduces your future capital gain.

• Calculate the Capital Gain Upon Sale

  The capital gain is your selling price, minus selling costs, minus your updated ACB. You pay tax on 50% of this amount.

Spousal Rollovers: A Key Exception

The tax rules provide a significant deferral opportunity when property is left to a surviving spouse or common-law partner. This is known as a “spousal rollover.” When this provision is used, the deemed disposition at fair market value does not happen upon the first spouse’s death. Instead, the property “rolls over” to the surviving spouse at the deceased’s original Adjusted Cost Base. This means that the capital gains tax is deferred. No tax is payable at the time of the inheritance.

This deferral is not a tax elimination. The tax is simply postponed until a later date. The capital gain continues to accumulate. The tax will become due when the surviving spouse sells the property or upon their own death. For instance, a husband buys a rental property for $200,000. When he passes away, it is worth $800,000 and he leaves it to his wife. The property transfers to her with the original $200,000 ACB. No tax is triggered at this point. If she later sells it for $900,000, her capital gain would be $700,000 ($900,000 minus $200,000). The spousal rollover is a powerful tool for estate planning, allowing the surviving partner financial stability without an immediate tax burden.

Unique Rules for Farm and Fishing Properties

The tax system recognizes the unique nature of family farms and fishing operations. It contains special rules to help these assets pass to the next generation without a crippling tax bill. Similar to the spousal rollover, there are provisions that allow qualified farm or fishing property to be transferred to a child or grandchild at the owner’s Adjusted Cost Base. This rollover defers the capital gains tax that would otherwise be triggered by the deemed disposition rule at death. It helps ensure the continued operation of the family business across generations.

To use this rollover, the property must meet strict criteria set by the CRA. These criteria relate to who owned the property and how it was used. Generally, the deceased, their spouse, or one of their children must have been actively engaged in the farming or fishing business. Due to the specific requirements, these situations require careful review. An executor should work closely with an accountant and a lawyer who specialize in agricultural or fishing transfers. They can confirm the property’s eligibility and ensure the transfer is structured correctly to defer the capital gains tax as intended by the law.

Conclusion

The question of capital gains on inherited property is layered. The immediate tax burden does not fall on the beneficiary. Instead, the deceased’s estate manages the tax implications through the deemed disposition rule. The estate calculates the capital gain based on the property’s value appreciation during the deceased’s ownership and pays the necessary tax. This means you inherit the property with a clean slate from a tax perspective. Your cost base becomes the property’s fair market value at the time you receive it, setting the stage for any future capital gains you might realize.

Key exceptions like the Principal Residence Exemption and spousal rollovers can defer or eliminate this initial tax for the estate. These rules are vital for effective estate planning. As the new owner, your responsibility is to understand your property’s new cost base and track any improvements you make. When you decide to sell, you will be responsible for the capital gains tax on the value increase during your ownership. Navigating this process requires good information and professional guidance. Working with a real estate professional, a tax accountant, and a lawyer ensures you make informed decisions every step of the way.