Whether leaving an inheritance or expecting to receive one, know the tax implications ahead of time.

Inheritance is often an overlooked aspect of financial planning, frequently taking a backseat to more immediate concerns. However, with Canada on the cusp of the largest intergenerational wealth transfer in history, it’s essential to have a clear understanding of the tax implications and financial considerations involved. 

Despite common misconceptions, inheritance and taxation are more complex than they appear. 

The Great Wealth Transfer: are you ready?

Known as "The Great Wealth Transfer," the silent generation and baby boomers are set to pass down a significant amount of assets to their younger family members. While this might sound like a great financial opportunity, many Canadians are unprepared for the legal, financial, and tax complexities that come with it. 

H&R Block Canada’s recent survey revealed more than half of Canadians are expecting to be beneficiaries of an inheritance, yet only a third feel they have a solid grasp on the tax implications involved.

Discussing inheritance can feel uncomfortable and awkward. More than half of Canadians (53%) admitted they haven't brought up the subject with family members, with almost a third finding it morbid to think about inheritance tax issues before the situation arises. But avoiding the conversation doesn't make the reality disappear. In fact, it can lead to missed opportunities to minimize tax burdens and ensure a smoother transition of assets.

Understanding the tax implications.

There’s a common myth that Canada doesn't have an inheritance tax, but before you start making financial plans or decisions, having the full picture is important. For example, while beneficiaries are not directly taxed on the inheritance they receive, the estate of the deceased may be subject to certain tax obligations.

When someone passes away, the Canada Revenue Agency (CRA) considers most of their assets to be "sold" at their current market value. If those assets have gone up in value over time, the estate may have to pay capital gains tax on the increase. For instance, if the deceased bought a cottage for $300,000 and it's now worth $400,000 at their passing, the estate might face taxes on the $100,000 gain. Knowing how capital gains are taxed can help you prepare for any potential tax bills.

Registered savings accounts: Important tax considerations. 

Registered savings accounts like RRSPs and RRIFs are another piece of the puzzle. Their full value is considered income in the year of death, potentially leading to significant tax liabilities for the estate. However, if these accounts are transferred to a spouse, common-law partner, or a financially dependent child or grandchild, they can be rolled over without immediate tax consequences.

Depending on where you live, the estate might be subject to probate fees, also known as estate administration taxes. These fees vary by province. For example, Ontario charges approximately 1.5% on estates valued over $50,000, while Quebec doesn't have any probate fees. 

Strategies to reduce tax impact. 

While taxes are inevitable, there are strategies to help reduce their impact on your inheritance.

If the deceased's primary residence is passed on, it may be exempt from capital gains tax. However, if the property was used to generate rental income or wasn't the primary residence for the entire ownership period, partial taxes might apply. 

TFSAs are the gift that keeps on giving. The growth and withdrawals from a TFSA remain tax-free for beneficiaries if the account is left to a spouse or common-law partner. For other beneficiaries, the TFSA ceases upon death, but the investment gains up to that point are passed on tax-free.

Life insurance payouts are generally tax-free for beneficiaries. Many Canadians use life insurance to cover potential tax liabilities on assets like cottages or businesses, ensuring those who inherit aren't forced to sell special assets to pay taxes.

Gifting money or assets before death can be a strategic move. However, be cautious: gifting certain assets, like real estate or stocks, might trigger capital gains tax at the time of the gift. It's essential to consult with an expert who can paint a picture of how that decision will play out, like an H&R Block Tax Expert.

If you add a family member as a joint owner to your assets—like a bank account or property—those assets can go directly to them when someone passes away, without going through the legal probate process. Additionally, setting up trusts, like Alter Ego or Joint Partner Trusts for those 65 and older, can help manage and protect assets while minimizing taxes. 

The bottom line: proactive planning pays off.

While it might be tempting to adopt a "wait and see" approach to inheritance, proactive planning can save you and your loved ones significant stress and money. Engaging in open conversations, understanding the tax implications, and seeking advice from an H&R Block Tax Expert can make the inheritance process smoother and more beneficial for all parties involved.

For more information on managing your taxes and estate planning, check out our other blogs:

Filing taxes for a deceased person

6 things to know about capital gains

If you have any questions about your tax filing obligations for a deceased loved one, H&R Block Tax Experts can help. Find an office near you to book an appointment today.