My friend, William, is the executor of his father's estate. His father, Jack, passed away two months ago. Jack was a hoarder. He loved the thrill of getting a deal on things. He once bought a year's supply of oatmeal because it was on sale. He also bought big-ticket items when he found a great price (a life-size wax replica of Willie Nelson, for example) – even if he didn't need or want the stuff. When Jack passed away, he had a home and seven storage units full of junk.
Today, William has the job of selling the home. Once the home is cleaned up, it'll be worth a lot of money because it's in a desirable neighbourhood in Toronto. I shared with William that there could be some tax savings when selling his father's place. And, like William, if you sell the home of a deceased loved one, you, too, could create some tax savings that will end up in the pockets of the heirs.
Jack's home is worth significantly more than its original cost. He paid $200,000 for the place many years ago and, at the time of his death, it was worth $1.2-million. At the time of Jack's death, the $1-million capital gain on his home was realized since, under our tax law, you'll be deemed to have sold all your capital property immediately before your death.
There are a few ways to defer or eliminate the tax on your assets when you pass away. Leaving your assets to your spouse is the first line of defence. Jack didn't have that option since his wife predeceased him. In the case of a principal residence, you can shelter the tax on any gains using your principal-residence exemption (PRE). This will ensure that, in Jack's case, there won't be any tax on the $1-million gain upon his death. When William files his father's final tax return, he'll have to report the deemed disposition of the principal residence on Schedule 3, which is a new requirement as of 2016, notwithstanding that there won't be any tax to pay on the residence.
Aside from the PRE, there may be another opportunity to save tax on Jack's final tax return. This idea is possible because William plans to sell his father's residence very soon. It's quite possible that a capital loss will be realized by the estate when the property is sold, which can save taxes.
Here's how: If you pass away, your estate will become the owner of your home after your death (assuming the home does not pass to a joint owner with right of survivorship). In Jack's case, the adjusted cost base of the home to his estate is $1.2-million – the fair market value at the time of his death.
Let's assume that William, as executor, will then sell the home for its current value of $1.2-million, less the costs of selling the home. So, the net proceeds to the estate will be less than $1.2-million. The result is that Jack's estate will realize a capital loss. There's a pretty good chance of that happening after your death, too. Don't forget, even if your executor sells your home for its fair market value at the date of your death, the selling costs alone (say, 6 per cent, or $72,000 in Jack's case) would create a capital loss.
Now, for the tax savings. If a capital loss is realized by the estate in the first taxation year of the estate, the loss can be carried back to the final tax return of the deceased, to offset any capital gains – or other income (yes, capital losses can be applied against any type of income in the year of death), that might have been taxable on that return. Subsection 164(6) of our tax law allows this loss to be carried back. That's right, Jack's heirs will be able to recover some tax that might have been paid on his final tax return if there's a loss in his estate when selling the home.
One last point: A principal residence is normally considered to be "personal-use property," and the taxman won't allow you, or your estate, to claim a capital loss on personal-use property. Not to worry. The residence will not be considered personal-use property provided none of the beneficiaries of the estate (or someone related to a beneficiary) lives in the home after the owner's death.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices.