Reporting Deemed Disposition Capital Gains on a Final Return in Canada

If you are the executor, one of the most surprising parts of a final return is that the deceased is treated as having sold their capital property on the day they died. The tax can arise even when the house, shares or land stay in the family.

This article explains the rule, where the gain is reported, and the main ways the tax can be reduced or deferred. It is general information, and complex estates are worth reviewing with an accountant or lawyer.

This article covers Canadian federal tax law, which applies in every province.

What deemed disposition means

Under section 70(5) of the Income Tax Act, each capital property is deemed sold immediately before death at fair market value. The person who acquires the property is deemed to acquire it at that value.

In plain words, the tax system treats death as a sale for tax purposes. You do not need to sell anything for the gain or loss to be counted.

Where it goes on the final return

The taxable capital gain or loss is calculated on Schedule 3 and reported on line 12700 of the final return. Income earned up to the date of death also goes on the final return, even if it is received after death, unless it is put on an optional return.

Income the estate earns after death, such as investment, business, farming and rental income, is reported on the T3 return and not on the final T1.

• Use the T1 package for the year of death and the province of residence at death, plus Form 428 outside Québec.
• Use Schedule 3 for capital gains, and Form T1255 for the principal residence.
• Gather information slips such as T4, T5, T4A(P) and T4(OAS).

Ways the tax can be reduced or deferred

Several rules can change the result. They have conditions, so check each one against the facts of the estate.

Common points of confusion

A frequent question is whether the estate must sell the property to pay the tax. The deemed sale happens for tax purposes whether or not there is an actual sale. Whether the estate has cash to pay the tax is a practical matter to discuss with a lawyer or accountant.

Another is the due date. For a death between January 1 and October 31, the final return and any balance owing are both due April 30 of the year following the death. For a death between November 1 and December 31, the final return is due 6 months after the date of death. Payment dates do not move with the later filing dates, and you may need to pay before filing to avoid interest.

Late filing with a balance owing can bring a penalty of 5% of the balance plus 1% of the balance for each full month late, up to 12 months. Interest is compounded daily on unpaid amounts.

What to do next

• Confirm you are the legal representative, usually the executor named in the will, or the liquidator in Québec.
• Notify the CRA of the death and send the documents it asks for.
• List every capital property and get its fair market value at the date of death.
• Note which properties pass to a surviving spouse or common-law partner, and decide whether to elect out of the rollover.
• Decide whether a principal residence should be designated on Schedule 3 and Form T1255.
• Do not distribute property until you have a clearance certificate, to avoid personal liability.

Valuations, elections and the choice between filing options can change the tax result. An accountant or lawyer can confirm the figures before you file.

Frequently asked questions