Tax Strategy
Death and Taxes
There are a variety of ways to reduce taxes on the taxpayer's terminal return.
FROM:
NOV-DEC 2003 ISSUE | BY
J.
THOMAS McCALLUM
One of the more interesting and challenging areas of income tax practice is accounting for taxes arising at death. A number of unique rules apply, which present opportunities to minimize taxes. Here we'll look at a selection of the more widely applicable rules and options.
Split-Choice Option
Most people are aware that if the deceased's capital property is left to his or her spouse, the deemed disposition of that property occurs at the adjusted cost base (ACB) or undepreciated capital cost (UCC) rather than at fair market value (FMV). Instead, one can choose to recognize the disposition at FMV, but it's an either/or choice. One cannot select a point between ACB/UCC and FMV. It is a property-by-property choice, which means one can select FMV on an individual property without affecting the automatic ACB/UCC proceeds on other properties.
While the split-choice rule appears to be black and white, I have seen many cases where it was not used to full advantage. It is used most commonly with a stock portfolio or real estate. Within the portfolio, each share is considered a separate property. For real estate, the building and the land are seen as separate properties, allowing one to opt for UCC on the building and FMV on the land.
Applying Capital Losses
At death, there is a suspension of the usual rule that capital losses can only be applied against capital gains. Any unapplied capital losses in excess of the deceased's accumulated capital gains deduction can be deducted from any source of income in the taxpayer's terminal return, or the immediately preceding year's return. The unapplied losses that can be used in this way include losses carried forward from previous years.
Estate's Losses
Any capital losses in excess of capital gains or terminal losses in excess of the related business or property income realized by the deceased's estate in its first taxation year are deemed to be capital and terminal losses realized by the deceased in his or her year of death. In all likelihood the deceased's terminal return has already been filed, and so it will have to be amended to report these losses.
Such losses can easily arise when there are costs such as brokerage and legal fees incurred in the disposition of the property. The estate's ACB is based on the deceased's FMV deemed disposition amount; consequently, a sale for close to the FMV amount results in a loss after factoring in the disposition costs.
Principal Residence Losses
Given that any gains on the deceased's principal residence are offset by the principal residence exemption, there is a tendency by most accountants to ignore the tax accounting for this property. That is probably a huge mistake.
A principal residence, like any other capital property, is deemed disposed of at FMV, and becomes the ACB of that property to the estate. Assuming none of the estate's beneficiaries choose to reside in the property, and further assuming that it is not rented out, the property loses its status as a principal residence and is no longer a
personal-use property.
This "loss of character" means that any loss realized by the estate on selling the property is a capital loss. If that capital loss is realized within the first taxation year of the estate, it can be used in the deceased's terminal tax return.
Other Loss-of-Character Properties
Eligible capital property is not capital property. If the deceased was carrying on a business and that business had an eligible capital property, there is no deemed disposition of the property at FMV. Instead, it is deemed disposed of at four-thirds of the cumulative eligible capital property (CEC) pool. If the person who receives the property does not carry on the related business, the property becomes a capital property. The recipient's ACB is the deceased's deemed disposition amount, and anything realized on a disposal at a greater amount is a capital gain. This is advantageous because there is no recapture of amortization previously claimed by the deceased. Also, capital gain will likely be more tax-favourable than business income.
Land inventory also has an unusual loss-of-character twist. While land inventory is deemed disposed of at FMV, such is not the case when it is left to a spouse, as it is deemed disposed of at cost amount (tax-basis inventory value). This becomes the inheriting spouse's cost. If the spouse is not in the land business, the land becomes a capital property and converts what would otherwise have been business income
(100 per cent taxable) into a much more favourable capital gain
(50 per cent taxable).
Optional Tax Returns
As many as four personal income tax returns can be filed for the deceased taxpayer in the year of death. Filing one or more separate returns is advantageous in that the deceased is considered a separate taxpayer in each return. Hence, the deceased is entitled to the basic tax credit, the spouse (or equivalent) credit, the dependant credit, and the age credit in each return. And income is taxed at lower rates than the marginal rate in the terminal return.
The most common separate return is one for rights or things such as declared dividends with a record date preceding death, due but unpaid salary or wages, and inventory of a
cash-basis business. Another return can be filed for business owners who died without fully reporting their reserve for
December 31, 1995, income, or died after the close of their fiscal year with an end date other than
December 31.
RRSP Contribution
While a deceased taxpayer cannot have a post-death contribution made to his or her RRSP, he or she can contribute to a spousal RRSP in the year of death. To ensure deductibility, the contribution should be made within
60 days of death.
Medical and Charitable Deductions
In the year of death, the usual rule that medical expenses can be claimed for any
12-month period ending in the taxation year is altered to any
24-month period that includes the date of death.
The $10,000 maximum deduction for attendant care, which is allowed if the deceased was mentally or physically impaired, doubles to $20,000 in the year of death.
Donations made in the year of death can be claimed in either the terminal tax return or carried back to the previous year, and the
75 per cent of income maximum that ordinarily applies to donations is increased to
100 per cent. Also, donations made under the deceased's will can be claimed in the terminal return or the previous year's return.
Taxes by Instalment
Rather than force an imprudent disposal of assets, the
Act allows the deceased's legal representative to elect to pay any taxes due because of the deemed disposition of capital properties, land inventories, resource properties and rights or things, in up to 10 equal annual instalments. While interest applies, it is fixed at the rate in effect at the time of the election.
These are just some of the opportunities for minimizing taxes at death. All should be used to the maximum extent possible, as this is the taxpayer's last chance to beat the tax department.
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J. Thomas McCallum, CBV, FCGA, is a business valuation and income tax consultant based in Whitby, Ontario. E-mail
jtmc@jthomasmccallum.com.
The information appearing in "Tax Strategy" is provided for the interest of the readers. Neither
CGA Magazine nor the column authors and co-ordinator assumes any responsibility or liability to any persons relying on the information in the article to perform tax planning and/or compliance of any kind.