Deceased’s Principal Residence – But I thought it wasn’t taxable!

Most Canadian homeowners are aware that generally they are not taxed on the increase in value of a property that qualifies and is designated as their principal residence.  There are a number of criteria to be met in order for a property to qualify as a principal residence for all years owned which I will not be going into detail here.  I would specifically like to discuss how a person’s principal residence is taxed after death where the property is sold and the cash proceeds distributed to the beneficiaries.

Here’s the short and not-so-sweet of it: A real estate property which was the deceased’s principal residence and has remained vacant since the date of death will be taxed on any gain in value from the date of death. It does not matter if it was the deceased’s principal residence and it does not matter if the property was sold in 6 months, 5 years or a decade after death.

I think a little Canadian Death & Taxes 101 may be needed to understand this reasoning.   When an individual dies, they are considered to have sold everything they own as of the day they die for the fair market value as of the date of death.  This is called a deemed disposition and if the deemed disposition of assets result in a gain, then tax will be payable on that gain.  Assuming a real estate property qualifies as the individual’s principal residence for all years owned, the gain on the real estate property will not be taxable.

Okay, stay with me for just a little bit more…  The deceased’s estate is a separate taxpayer from the deceased and the estate is considered to have acquired the deceased’s assets for the fair market value at date of death.  This fair market value at death becomes the estate’s cost and when the estate finally sells the assets, the estate will be taxed on any gain from the date of death.  This includes a real estate property which was the deceased’s principal residence, but has remained vacant since the date of death.

Why is this such a common misconception?  Possibly because the real estate commissions are deductible from the gain so it would be unusual for a property sold within one year of death to have a taxable gain.  However, in some real estate markets such as Vancouver, this is not out of the question.  Others may be confused because of the principal residence “plus one year” rule.  However, for the “plus one year” rule to apply, the property must have first qualified as a principal residence.  Since the estate is a new and separate taxpayer of the deceased it does not get to use the deceased’s “plus one year”.  Similarly, if I bought property from you which was your principal residence, I don’t get to claim your “plus one year”.  The property must first qualify as my principal residence and then I get my own “plus one year”.  I have also heard the argument that because the Executor can’t sell the property until they get Probate (which can take up to a year or more), it is unfair to tax the gain on the property when it was sold as soon as legally possible.  My counter-argument would be if this was true, then why doesn’t the same logic apply to all of the Estate’s assets like mutual funds and investment shares (which of course it doesn’t).

What if the Executor sells the real estate property at a loss (ie. for less than the fair market value at date of death)?  The estate will get to use the loss to reduce any gains realized on other estate assets.  If the loss is in the first year of the estate, the Executor may be able to request the loss be carried back to the Date of Death T1 and recover income taxes paid.  Also, it is possible for real estate held by an estate to qualify as a principal residence.  I will not go into the mechanics of either now, but I would strongly recommend anyone looking to use these strategies seek the advice and assistance of a professional accountant who regularly handles estate tax matters.

For more detailed information or if you have a specific situation you would like to discuss, go to our firm website to view our contact information.  You may also wish to refer to CRA’s Guide T4011 – Preparing Returns for Deceased Persons and Income Tax Folio S1-F3-C2: Principal Residence.

Until next time,

Heather

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