Let’s face it: nobody likes talking about death. But given that the end of one’s life triggers one of our highest tax liabilities, it’s worth seeking advice on how to reduce the cost.
When it comes to capital property, being survived by a spouse can provide tax planning flexibility. Much of this planning centers around capital gains. However, some interesting planning with capital losses can also provide benefits on the final tax return.
The basics and the election
At death, there is a deemed disposition of our capital property at fair market value (FMV). This triggers capital gains or losses in our final year. The net capital gains are taxable in that same year. Should there be net capital losses, an estate representative has two options:
- Method A: carry back the net capital losses to reduce taxable capital gains from the previous three tax years. If a capital loss remains, it can be used to reduce other income on the final return and/or the year before the year of death.
- Method B: simply use the net capital losses to reduce income on the final return and/or the year before the year of death.
For those who die without a spouse and with net capital losses, tax planning as it relates to capital property is limited to methods A or B. If a taxpayer expects there will be capital gains remaining on death after the losses are used up, options include purchasing life insurance to cover the tax liability, making charitable donations at death or realizing the gains while alive via a gift.
For those who have a spouse (married and common-law partners) who becomes the owner of capital property, however, the deemed disposition at FMV is not the default treatment. Capital property can be transferred to the spouse at its adjusted cost base (ACB), allowing for a tax deferral.
However, the surviving spouse ultimately must pay the tax liability when they dispose of or are deemed to have disposed of the assets.
While this spousal rollover can be advantageous, it isn’t always. Fortunately the Income Tax Act (ITA) allows the estate representative to choose, on a property-by-property basis, whether to transfer at FMV or at the ACB.
Choosing to transfer the property at FMV may be beneficial under the following circumstances:
- The deceased has capital losses carried forward from previous years. Using the election to realize capital gains on certain capital assets can allow the losses to be used while not increasing the deceased’s tax bill. Additionally, the election allows the cost base for the spouse on the same property to be bumped up to FMV when he or she subsequently inherits it.
- The deceased owns qualified small business corporation (QSBC) shares or qualified fishing and farming property with unrealized capital gains and an unused lifetime capital gains exemption (LCGE). Electing to transfer at FMV instead of at ACB can allow the deceased to use their LCGE and increase the cost basis of that same property for their surviving spouse.
- The deceased has property with an accrued loss. The election can allow the capital loss to be realized since the superficial loss rules do not apply at death. The deceased’s estate representative can then utilize either Method A or B to maximize the tax benefits of these losses.
The first two options are widely known reasons for electing out of the spousal rollover on a property-by-property basis. But using this election on a property with a capital loss combined with methods A and B can be beneficial for post-mortem tax planning.
Such flexibility in tax planning can be invaluable, especially at a time when taxes may be at their highest. How’s that for a spousal advantage?
Curtis Davis , FMA, CIM, RRC, CFP, is senior consultant, Tax, Retirement & Estate Planning Services, Retail Markets at Manulife