Perhaps the two spookiest words in my world are death and taxes. But with
some advance planning, the two don't always have to come hand in hand.
Upon death you are deemed to dispose of all of your "capital property" at
fair market value. What is capital property? Pretty much everything you own:
stocks, bonds, mutual funds, business properties and real estate (other than
your principal residence, which is generally tax-free). The term "deemed
disposition" is used because you're taxed on any increase in value, even if your
estate doesn't actually dispose of the asset, but merely transfers it to a
surviving beneficiary.
The amount of tax payable on this deemed disposition at death is calculated
by subtracting the tax cost of any assets from their fair market value upon
death. This difference (if positive) is then multiplied by 50% since it's
considered to be a capital gain, and is taxed at your marginal tax rate for the
year of death.
For example, if Noah died owning a portfolio worth $1,000,000, that had a tax
cost of $400,000, his capital gain on the deemed disposition at death would be
$600,000. Since only half the gain is taxable, his estate would owe taxes on
$300,000. Assuming a 45% tax rate, $135,000 of taxes would be payable on Noah's
death.
There are a couple of ways to avoid this deemed disposition at death. The
first, and most common, one is to simply leave any appreciated capital property
to a spouse or common-law partner. By doing so, capital gains tax can be
deferred until the surviving spouse or partner either sells the property or
dies.
So, if Noah had left his portfolio to his wife, she would be deemed to
inherit the portfolio at Noah's original tax cost of $400,000, deferring the
$600,000 gain until later.
The second -- and most overlooked -- method of avoiding capital gains tax on
death is by using an "inter vivos" gifting strategy. Essentially, this means
giving away any excess property or investments throughout your lifetime before
they appreciate significantly in value.
This is a wonderful opportunity because Canada, unlike the United States,
does not impose a gift tax. You can make a gift of as much money as you want, to
anyone you want (as long as they're at least 18 years of age) and there is
generally no tax payable on the gift.
In the U.S., by contrast, a gift tax is imposed on the transferor, subjecting
him or her to a tax on any gifts over US$12,000 per recipient.
Be careful when giving away appreciated property as you will be deemed to
dispose of it at fair market value and subject yourself to immediate capital
gains tax. The strategy of gifting makes the most sense when dealing with either
cash or assets that haven't accrued significant gains. By gifting in advance of
death, any future gains can be deferred and taxed in the hands of sometimes
lower-taxed recipients (kids, nieces, nephews, etc.), who may be better able to
use the money now.
And, as an added bonus, if you live in a province that imposes a probate tax
upon the value of your estate when you die, you can avoid the tax on the value
of any assets given away before death.
Finally, before you give, make sure that you won't need the money later. The
biggest problem with giving a gift is that it's very hard to get it back.
GRAPHIC: Black & White
Photo: Peter Redman, National Post; (Tombstone).