Inheriting property in Canada can be a significant life event, but it often comes with complex tax implications. While Canada does not have a formal “inheritance tax” levied on the beneficiary, the estate of the deceased is subject to tax, primarily due to the “deemed disposition” rule. Understanding this, and the subsequent tax implications for the beneficiary, is key to minimizing your tax burden.
1. Understanding the Tax Fundamentals of Inherited Property
In Canada, when an individual dies, the Canada Revenue Agency (CRA) considers that the deceased has “deemed to have disposed of” all their capital property (including real estate, non-registered investments, etc.) immediately before death at its Fair Market Value (FMV).
A. The Deemed Disposition
Who Pays the Tax? The resulting capital gain (FMV at death minus the original Adjusted Cost Base, or ACB) is reported on the deceased’s final income tax return (the “Terminal Return”) and the tax is paid by the estate.
The Inheritor’s ACB: The beneficiary (the inheritor) is deemed to have acquired the property at its FMV on the date of death. This FMV becomes the beneficiary’s new Adjusted Cost Base (ACB).
B. Capital Gains and the Inclusion Rate
Capital Gain: The gain is calculated as Proceeds of Disposition (Selling Price) – Adjusted Cost Base – Selling Expenses.
Taxable Gain: Only a portion of the capital gain is taxable. The Capital Gains Inclusion Rate determines this percentage. As of the latest changes, the inclusion rate is scheduled to increase for gains above a certain threshold for individuals. Check with a tax professional for the current rates applicable to your situation. The taxable gain is then added to the taxpayer’s regular income and taxed at their marginal tax rate.
2. Strategy 1: Utilizing the Principal Residence Exemption (PRE)
The Principal Residence Exemption (PRE) is the most powerful tool for minimizing tax on residential property in Canada.
A. For the Deceased (The Estate)
Was the Property the Deceased’s Principal Residence? If the inherited property was the deceased’s sole or principal residence for every year they owned it, the capital gain resulting from the deemed disposition at death is completely sheltered by the PRE.
Action for the Executor: The executor must designate the property as the deceased’s principal residence on the final tax return (using Form T2091 for partial exemption or simply reporting the sale on Schedule 3 and checking the PRE box if fully exempt) to eliminate the capital gains tax liability for the estate.
Impact on Beneficiary: If the PRE fully shelters the gain on the Terminal Return, the beneficiary inherits the property at its full FMV, with zero tax paid by the estate on the past appreciation.
B. For the Beneficiary (The Inheritor)
If you inherit the property and decide to sell it later, your capital gain is calculated from your new ACB (the FMV at the time of death).
Move In and Designate it as Your Principal Residence: If you move into the inherited property and make it your primary residence, you can designate it as your principal residence. Any future appreciation from the date of inheritance until the date you sell it will be tax-free under your own PRE.
The “Plus One” Rule: When you sell a property that has qualified as your principal residence, the PRE formula includes a “plus one” rule, allowing the exemption for one extra year. This is particularly helpful when you purchase a new home in the same year you sell the old one.
3. Strategy 2: Spousal Rollover (Deferring the Tax)
This is a powerful tax deferral strategy when a property is inherited by a surviving spouse or common-law partner.
Automatic Rollover: When capital property, including real estate, passes to a surviving spouse or spousal trust, the transfer generally occurs on a tax-deferred basis (or “rollover”).
No Immediate Deemed Disposition: The deceased’s estate generally does not have to report a capital gain on the Terminal Return. The property is transferred to the spouse at the deceased’s original Adjusted Cost Base (ACB), and the tax is deferred until the surviving spouse sells or dies.
Executor Election: The executor can elect out of the spousal rollover if they wish to use the deceased’s capital losses or utilize the deceased’s Principal Residence Exemption for a property for certain years. This is a complex decision that requires professional advice.
4. Strategy 3: Selling Quickly After Inheritance
If the inherited property is not the deceased’s principal residence (e.g., a rental property or a cottage) and is not passing to a spouse, the estate will pay the capital gains tax up to the date of death.
Minimal Post-Inheritance Gain: Since the beneficiary’s ACB is the FMV on the date of death, selling the property soon after inheritance will likely result in a very small capital gain (or even a loss), as market value changes are minimal over a short period.
Tax Only on Appreciation Since Death: The inheritor (or the estate, if sold by the executor) will only be taxed on the appreciation (gain) between the date of death and the date of sale.
5. Strategy 4: Deducting Costs and Expenses
The overall capital gain can be reduced by ensuring all eligible costs are deducted.
Add to Adjusted Cost Base (ACB): For the deceased, the ACB includes the original purchase price plus major capital improvements (e.g., a new roof, new addition) but excludes simple repairs and maintenance.
Deduct Selling Expenses: For both the estate (on the deemed disposition) and the beneficiary (on a subsequent sale), you can deduct expenses related to the sale, such as:
Real estate commissions.
Legal fees associated with the sale.
Appraisal costs to determine the FMV at the date of death (which is critical for setting the inheritor’s ACB).
6. Planning Ahead: Pre-Death Considerations
While the inheritor has limited control over the deceased’s planning, awareness is key.
| Pre-Death Strategy | Description | Tax Impact |
| Gifting the Property | Transferring the property to the inheritor before death. | Triggers an immediate deemed disposition for the parent at FMV, resulting in a capital gains tax bill today. Generally not an effective tax-saving strategy. |
| Joint Tenancy (JTWROS) | Adding a child as a joint tenant with right of survivorship. | Bypasses probate (saving probate fees) but may not completely avoid capital gains. The initial transfer is a partial deemed disposition. Complex rules apply regarding beneficial ownership. |
| Using a Trust | Transferring the property into a testamentary trust (created on death) or an alter ego/joint partner trust (created while living). | Can defer capital gains tax until the death of the surviving spouse/partner. Very complex; requires legal advice. |
| Life Insurance | Purchasing a permanent life insurance policy where the death benefit is sufficient to cover the expected capital gains tax liability. | The death benefit is tax-free and provides the estate with liquidity to pay the tax bill, preventing the forced sale of the property. |
✅ Key Takeaways
No Inheritance Tax: The tax burden falls on the deceased’s estate, not the beneficiary.
Deemed Disposition: All non-exempt capital property is considered sold at FMV on the date of death, triggering capital gains.
Principal Residence Exemption (PRE): If the property was the deceased’s PRE, the estate pays zero tax on the past appreciation.
Spousal Rollover: Inheritance by a spouse defers the tax until the spouse sells or dies.
New ACB: The inheritor’s starting cost (ACB) is the FMV on the date of death.
Action Item: As an executor or beneficiary, the most critical step is to obtain a professional appraisal of the property as close to the date of death as possible. This establishes the accurate Fair Market Value (FMV), which is essential for both the deceased’s final tax return and the inheritor’s future tax calculations.
Need an Inherited Property in Canada? Contact Aura Finance Personal Tax Accountants in Toronto.