Five basics to know about inheritance taxes

Updated November 9, 2023

The expression “as sure as death and taxes” lists the two things that are inescapable realities. While everyone’s demise is certain and no one is exempt from this fate, you may be surprised to know that some taxes after death aren’t always 100% guaranteed. This can be true of Canada’s inheritance tax.

Is there an inheritance tax in Canada? Do beneficiaries need to declare their inheritance on their tax returns? What is an estate tax and how is it applied? Do you pay capital gains taxes on your inheritance? In this article, Wealth Professional offers some answers. Here are 5 basics to know about inheritance tax.

1. Is there an inheritance tax in Canada?

The truth of the matter is that there is no inheritance tax in Canada. When someone dies, their legal representative or executor files their final tax return. The final tax return reports on income earned up to the date of their demise. Any remaining debts are paid from the estate of the deceased, then the remaining assets or funds are awarded to the beneficiaries.

Is there an estate tax in Canada?

There is no estate tax in Canada either. However, every province except Quebec and Alberta charges a probate fee.

In Ontario there is no probate fee charged to small estates up to $50,000, but a fee of $15 per $1,000 is charged to estate assets valued at over $50,000.

What rules are applied to a deceased person’s estate?

The deceased’s estate, or all the assets and liabilities they leave, are taxed by the Canada Revenue Agency (CRA). In general, there are two rules that are applied to their estate:

1. Deemed Disposition
2. Deemed Withdrawals

When a person dies, all their assets are treated as if they were all sold on the day before their demise. This is the Deemed Disposition. The taxes are deducted from that “sale” of the assets, with their prices set at the fair market value at the date of death.  

If after the Deemed Disposition there is a difference between the original purchase price and the market value at the time of death, this is considered profit on the sale of the assets.

The profits or proceeds are then used to calculate the capital gains on the sale. 50% of the capital gains is taxable to the estate.

Deemed Disposition

Deemed disposition can be applied to the income properties (ex. rental properties) and their non-registered investments like mutual funds, ETFs, etc.

Note, however, that certain tax exemptions, tax deferrals, or tax reductions are possible if the deceased has a spouse or common-law partner as a beneficiary.

If the deceased has a spouse or common-law partner who inherits their estate, which can include:

• real estate properties (primary residence, vacation house, investment property)
• registered accounts (RRSPs, RRIFs)
• other investments

the spouse or common-law partner will usually pay less taxes, but only if they are a Canadian resident, and the estate is transferred within 36 months of the deceased’s passing.

The transferred assets will be treated as having the market value they held at the time of death.

Income tax on the estate may also be deferred if the deceased has a qualifying survivor who inherits them, such as:

• A financially-dependent child or grandchild who is under 18
• A financially-dependent, mentally or physically infirm child of grandchild (any age)    

Does Deemed Disposition apply to all properties of the estate?

No - there are some items in some instances where Deemed Disposition doesn’t apply, such as:

Rollover to surviving spouse

In certain conditions, the deemed disposition cannot apply to property if there is a spouse or common-law partner eligible for inheritance. What's applied is similar to a tax deferral, so the property can't be taxed until the death of the surviving spouse or common-law partner. And since the assets left to a spouse automatically roll over, there are no forms to fill out.  

Tax exemption on principal residence

Any capital gains or profits on the dead person’s primary or principal residence is not taxable. In case the deceased owned more than one residence, any capital gains on each residence are calculated, and the lower taxes are applied.

Tax exemption on life insurance

The death benefit of a life insurance policy is not taxable. While the amount may be included in the estate, it can be used to pay any debts or pay any other taxes. This way, the heirs need not resort to selling any inherited property.

Here’s a financial advisor talking about the taxes and probate fees to expect, how the Deemed Dispositions and Deemed Withdrawals can work, final tax returns exemptions and other information about what to expect tax-wise, once someone has died:

Deemed Withdrawals

Upon death, all the deceased’s registered investments (e.g., RRSPs or RRIFs) are treated as if they were all withdrawn, and the entire amount is taxable. However, the taxes payable can be reduced or deferred. For example, the money can be transferred to an eligible person, so it’s considered as not withdrawn, and therefore isn’t taxable.

What are the deadlines for filing of final tax returns to CRA?

The deadlines for filing and submitting final tax returns to the CRA depend on when the person died. The deadlines are as follows:

2. Do I need to report inheritances or inheritances as gifts from foreign sources?

While most gifts or inheritances don’t need to be reported to the CRA, some inherited assets must be declared, depending on their type, value, and if they earn income.  

For instance, you have foreign assets like property, bank deposits, shares in a corporation, real estate with rental income, etc., and their combined value exceeds the $100,000 limit, then fill out Form T1135. This is the Foreign Income Verification Statement and is due on the same date as your income tax return.

Is a cash gift taxable in Canada?

If an inheritance is given as a “gift” in the form of cash, then it’s not treated as income by the CRA. So no, you don’t have to pay taxes on the money.

3. What happens if your inheritance increases in value after you receive it?

Let’s say you invested your inheritance money, and it earned an income in the form of interest or dividends. Should this happen, you will simply be taxed on the income earned, not the entire amount. The same applies to selling a capital asset, and it increases in value from the time you inherited it – you only pay tax on the capital gains.

4. Why is it important to know about inheritance tax in Canada?

Knowing about inheritance taxes is especially important for Canadians – not declaring assets that are taxable can result in heavy penalties and jail time. In other words, if it’s proven that you willfully committed tax evasion.

There are of course other good reasons for learning about Canada’s inheritance tax:

• It can assist in estate planning
• The knowledge can help you in tax planning
• You can avoid certain taxes (tax avoidance is legal while tax evasion is not)
• You can know how to avoid double taxation if you inherit assets from other countries
• Understanding the tax implications if you inherit assets from other countries

What is the difference between tax avoidance and tax evasion in Canada?

When a person or business intentionally hides income, exaggerates tax-deductible expenses, or falsifies claims or records to avoid Canada’s tax laws, that is tax evasion.

Tax avoidance, on the other hand, is using legal methods to reduce the amount of payable income tax. This can be achieved by taking as many tax credits and tax deductions as possible.  

5. How can I avoid or reduce taxes on my estate when I die?

There are several strategies you can use so that you or your heirs pay less on the inheritance you leave them, such as:

• Leaving your properties to your spouse
• Leaving your RRSP and/or TFSA to your spouse
• Leaving your RRSP to your financially-dependent children or grandchildren
• Purchasing life insurance
• Giving some of your property to family members while you’re still around
• Creating a trust for the assets
• Making donations to a registered charity

Canada is one of the few developed nations where citizens pay less taxes. And although there is no inheritance tax in the strictest sense, you will still have to pay final tax returns when you die. The heirs named in your will likewise have to pay some income tax on certain assets as well.

That’s why it’s worth knowing how to navigate tax laws on inheritance in Canada, apart from having a will. Familiarize yourself with estate planning and estate taxes.  Consult a financial advisor on these matters. Doing so can ensure that your loved ones reap the full benefits of the assets you worked hard to accumulate in your lifetime.

Did you find the answers you were looking for in this article about inheritance taxes (or the lack of it) in Canada? What strategies will you use in your estate planning? Let us know in the comme