With the cooling real estate market, an executor of an estate may be left with a property that has decreased in value during the ownership of the estate. During these uncertain times, a question arises – can an estate take advantage of the decrease in market price to reduce taxes on the disposition of a principal residence?
Under the Income Tax Act, an individual is generally deemed to have disposed of all his or her property at fair market value (“FMV”) immediately prior to their passing. The “deemed disposition” triggers capital gains on which taxes are payable. In the case of a principal residence that is 100% owned by the deceased individual, any resulting capital gain can be sheltered by the principal residence exemption. Subsequently, the FMV of the property at the date of death becomes the cost of the property to the estate.
Generally, the Income Tax Act doesn’t allow a person to claim a capital loss from selling their principal residence, as it is considered a “personal-use property”. However, given that the deceased person and their estate are treated as separate persons for tax purpose, the Canada Revenue Agency has asserted that the individual’s principal residence will not be deemed to be a personal-use property to the estate, if the property has not been used by any of the beneficiaries of the estate or anyone related to them. Where the property is not deemed to be a personal-use property, the estate could then take advantage of the capital loss realized from the disposition of a property to reduce the taxes on other capital gains in the year or carry the loss forward for future years.
Additionally, if the disposition occurs within the estate’s first taxation year, the executor of the estate could make a special election to carry the capital loss back to the final personal tax return and offset against other gains in the year to recover previously paid taxes.
Illustration of Tax Implications
John passes away owning his principal residence that was purchased for $500,000 and is now worth $1,500,000. If the property is used as John’s principal residence for all the years of his ownership, there would be no tax payable on the property on John’s final tax return. The cost of the property to the John’s Estate is now $1,500,000.
With the cooling housing market, John’s Estate sells the property for only $1,200,000 and incurs a capital loss of $300,000 ($1,500,000 – $1,200,000). Assuming that the house was not used by any beneficiaries of John’s Estate for personal use or enjoyment, John’s Estate can claim the $300,000 capital loss to offset other capital gains in the year.
If the property is sold within the first year of the estate, the executor of John’s Estate can elect to carry back the $300,000 capital loss to the final tax return of John to recover approximately $80,000 ($300,000 x 50% x 53.53%) of previously paid taxes, based on the top marginal tax rate in Ontario.
In this example, John’s Estate is able to avoid paying any tax on the capital gain from the “deemed disposition” while also triggering a tax-deductible capital loss on the same property.
GG Observations
With the cooling real estate market, executors of estates may be left with properties that have decreased in value during the ownership of the estate. With careful planning, the estate is able to receive relief from the decrease in value by realizing a capital loss and carry the loss back to recover previously paid taxes, if applicable.
Grewal Guyatt LLP has extensive experience in assisting clients with post-mortem tax planning and estate administration. If you are looking for more information about potential tax implications on the disposition of estate assets, carrying back of capital losses and other post-mortem strategies, please contact our tax team.
Authors
Rick Grewal, CPA, CA, TEP
Managing Partner
Contact Rick
Email: rick@grewalguyatt.ca
Direct: (905) 597-1701
Mandeep Khosa, CPA, CA
Partner – Tax
Contact Mandeep
Email: mandeep@grewalguyatt.ca
Direct: (905) 780-3117