Capital Gains Tax on Death: Investments, Cottage and Who Pays

Many families expect that nothing is taxed until an inherited investment account or cottage is sold. In Canada, the tax rules work differently. At death, the deceased is treated as having sold their capital property, whether or not anything was actually sold.

This article explains how that deemed sale works for investments and a cottage, who deals with the tax, and what trustees and heirs should check before handing out the estate. The numbers in your case depend on values and the deceased's tax history, so an accountant should confirm the details.

The deemed sale at death

The CRA treats the deceased as having sold all capital property just before death at fair market value. Gains and losses are reported on Schedule 3 of the final return. This applies to things like investment accounts held outside a registered plan, and to real estate other than a principal residence.

Because the sale is deemed, no cash is received from a buyer. The estate may need to sell assets, or use other funds, to pay the tax. Heirs generally cannot count on receiving investments in full if tax is owing on them.

The CRA capital gains page does not say who pays the tax. In practice it falls to the estate, because the estate trustee is responsible for paying taxes, bills and other debts.

When a spouse inherits: the rollover

Property passed to a surviving spouse or common-law partner who was a Canadian resident at death generally is not taxed at death. The gain is deferred until the spouse sells the property or is deemed to sell it. The property must be locked in within 36 months of death.

The legal representative can elect out of the rollover, property by property, on the final return. A testamentary spousal trust can also qualify. Whether electing out makes sense is a tax planning decision, so it is worth making with an accountant.

The cottage and the family home

A home the deceased ordinarily inhabited can be designated as a principal residence, which may exempt some or all of the gain. The disposition must still be reported on Schedule 3 with Form T1255. The designation covers only years up to the date of death.

A cottage used for personal enjoyment is personal-use property. Its gain is reported on Schedule 3, and a capital loss on it cannot be claimed. It is exempt only if it is designated as the principal residence.

If the deceased owned both a home and a cottage, you may have to think about which one to designate. That choice affects the tax, so get advice before the final return is filed.

Losses, and protecting the trustee

Net capital losses from the final return and the year before death can reduce income other than capital gains. Losses on personal-use property generally cannot be claimed.

A legal representative who distributes estate property before getting a CRA clearance certificate can be personally liable for unpaid tax, up to the value of the assets distributed. The application is made on Form TX19, but only after returns are filed, assessments are received and amounts owing are paid or secured. The CRA sends an acknowledgement within 45 days, and assessment can take up to 120 days.

The tax rate that applies to gains is not covered here and can change, so ask your accountant for the current figures.

What to do next

• List every asset and get a fair market value as of the date of death, including the cottage.
• Gather the original cost of each investment and the property.
• Note which assets pass to a spouse or common-law partner and whether the 36-month lock-in can be met.
• Decide with an accountant whether to elect out of the rollover on any property.
• Consider which property, if any, to designate as a principal residence.
• Keep enough in the estate to pay the tax, and wait for the clearance certificate before final distributions.

If heirs disagree about selling the cottage or sharing the cost of the tax, speak with an estate lawyer about your options.

Frequently asked questions