Building an estate takes a lifetime. And when the very person who built the estate dies, settling his/her lifetime savings and assets is no mean feat. It needs a lot of paperwork, from informing the Canada Revenue Agency (CRA) of the death to filing the final returns of the deceased, settling any previous tax obligations, and distributing the assets to the beneficiaries. Any slip-ups in this process could result in significant beneficiary tax liabilities.

The Role of Accountant in the Working of An Estate 

Canada does not have an inheritance tax, which means the beneficiaries do not pay tax on inherited assets. However, there are taxes the estate must pay before distributing the assets to the beneficiaries.

When the estate owner dies, the CRA deems the deceased to have disposed of their capital property at fair market value (FMV) immediately before death. This deemed disposition may generate a capital gain or loss, which must be included in the deceased’s final tax return.

T1 Final Return

The accountant first files the T1 Final Return of the deceased for the income generated from January 1 to the date of the death.  This return will also include the capital gains or losses on the deemed sale of assets described above. Suppose the deceased, who did not have a spouse, purchased a rental house for $200,000, and the FMV of that property at the date of death is now $500,000. The capital gain of $300,000 will be included in the final return, and the tax liability will be paid using funds from the estate. Sometimes, certain assets are sold to pay the obligation if the deceased did not have cash available to pay the tax liability.

If the deceased has a surviving spouse or common-law partner, most assets can be “rolled over” to that person at cost. This is only an option for a spouse or common-law partner. Using our example above of the rental property, the adjusted cost base of $200,000 would transfer to the spouse/common-law partner and no capital gain would be reported on the final return of the deceased. Instead, the capital gain will either be reported when the surviving spouse or common-law partner dies or disposes of the asset, whichever comes first. If the spouse or common-law partner sells the property when the value has increased to $600,000, the capital gain of $400,000 would be reported on the spouse/common-law partner’s return in the year of sale.

Using this rollover provision often makes sense because it defers the tax. However, in some situations it is better not to use the rollover provision and instead report the gain on the final return of the deceased. For example, if the deceased has capital losses or other credits that need to be used, it might be advantageous to report the capital gain on the final return. Then, the spouse or common-law partner would assume a cost base equal to the fair market value at the time of death, lowering their capital gain when they eventually sell the property.

As part of completing the T1 Final Return, your McCay Duff LLP consultant will analyze whether using the rollover provision makes sense for each asset and discuss the advantages and disadvantages with the surviving spouse or common-law partner and/or legal representative of the estate.

Rights or Things Return

A “Rights or Things” return is an optional special tax return that can be filed for certain types of income that a deceased person was entitled to receive but had not yet received at the time of their death. Eligible items for inclusion in a rights or things return include unpaid salary, dividends declared but not yet received, and matured bond interest. One significant advantage of filing a rights or things return is the potential to reduce the overall tax liability by spreading the deceased’s income over multiple returns, which can result in lower marginal tax rates and increased access to personal tax credits. However, this approach also comes with disadvantages, such as the complexity and additional administrative burden involved in preparing and filing a separate return.

Your McCay Duff LLP consultant will determine whether a rights or things return makes sense in the deceased’s circumstances and prepare one if the benefits exceed the effort required. Otherwise, income that could be included on the Rights or Things return will be added to the Final return instead.

T3 Trust Income Tax and Information Return

Most estates will retain assets for a period as the trustee addresses outstanding obligations and manages the sale of assets.  The estate must file a “T3 Trust Income Tax and Information Return” for this period between the date of death and when the funds are eventually distributed to the beneficiaries. This T3 return will include the income generated after death from the assets held in the estate, such as dividends on shares and rent on real estate property. The estate must also pay tax on this return.

If it takes more than one year for the assets to be distributed, the estate will likely have to file more than one T3 return. On the other hand, if all the deceased’s assets are transferred to their surviving spouse or common-law partner at death, it’s possible that a trust return might not be necessary.

A professional accountant can determine the T3 filing obligations for the estate and ensure that each income item is reported on the correct return.

The Role of Accountant in Assisting Beneficiaries with Inheritance Tax Returns

While an estate accountant plays a crucial role in filing estate returns and paperwork to distribute the estate, they also assist beneficiaries in managing their inheritance. Let’s understand this with the help of an example.

Andy is a 22-year-old college student. His grandfather leaves him  two real estate properties that earn $20,000 in annual rent. Once the properties have been transferred to him, Andy must report the rental income in his income tax returns. Adding new income will complicate tax filing as expenses like home repairs, property insurance, and property management expenses can be deducted from the rental income to save on taxes.

• The accountant can help Andy file his returns and provide financial advice regarding the property.
• The accountant can guide Andy on what is taxable and tax-free, along with various deductions and tax credits.
• The accountant can help Andy plan future tax obligations (capital gains tax) from the inherited assets, and make sure that Andy understands his cost base of the property.

Suppose Andy decides to convert the rental apartment into his principal residence. In that case, the accountant can guide him through the property’s status change and its tax implications and benefits.

Assist Beneficiaries with Tax Planning to Minimize Estate Taxes

Real estate is just one example. Each asset class has different tax rules and deductions. The estate accountant can help beneficiaries adjust to the new inherited assets and guide them on ways to reduce tax liabilities.  Early tax planning can go a long way in reducing tax liabilities and helping to sustain an inheritance. 

Contact McCay Duff LLP in Ottawa to Help You with Estate Execution 

A professional accountant can help the one-building estate and the estate’s beneficiaries on various fronts, from reporting income to tax planning to staying compliant with tax laws. At McCay Duff LLP, our accountants and tax advisors can provide services like filing returns and implementing tax strategies. To learn more about how McCay Duff LLP can provide you with the best accounting and tax planning expertise, contact us online or by telephone at 613-236-2367.