At the first death, the property can be transferred to the surviving spouse. At the second death, there would be a presumed disposition as if the property were to be sold at its then fair market value with corresponding capital gains tax. It may also be helpful to state that if the parents were to claim depreciation (capital expense deduction), a chargeback (income withdrawal and tax owed at regular tax rates) would occur. This would apply if they sold it to him, turned it over to him, or at the second death.
At the first death, the assets can pass to the surviving spouse, tax-free. At the second death, there would be a presumed disposition as if the property had been sold at the then fair market value with corresponding capital gains tax. If the parents were to claim depreciation (deduction of capital costs), a recovery (income withdrawal and tax owed at the regular tax rate) would take place. This would apply if they sold it to him, turned it over to him, or at the second death.
What About Inheritance Taxes and Inheritance Taxes?
Very often, decisions about whether or not to pass property through an estate are clouded by an overwhelming desire to avoid estate taxes.
In Canada, beneficiaries do not pay any estate or inheritance taxes. Instead, taxes are levied on the estate before it is distributed. Assets passing through the estate are subject to estate or inheritance tax. These fees, often misinterpreted as taxes, are administered by the provincial courts. They pay for the standard court services that help verify and legally transfer an individual’s estate to an elected heir (and certain assets are exempt, such as property held as a co-tenant or registered accounts with designated beneficiaries).
In the grand scheme of things, the probate fees are relatively small. For example, if your parents lived and died in Ontario, their estate would be charged at $0 on the first $50,000 of their estate, and $15 for every $1,000 above that. That would amount to $3,000 in administration fees for a $250,000 estate, plus legal fees.
Other factors to consider:
Probate fees are not the only factors to consider. When an entire estate is left to an heir, the final tax bill can be quite substantial. All unrecorded assets in all accounts are deemed to have been sold at fair market value (FMV) – this is called a deemed disposal – and the capital gains on the assets are then taxed. (The fair market value minus the cost basis.)
One option is to transfer ownership of the property to an heir before death. This means that the assumed disposal of the property is taxed using the owners’ current marginal tax rate. The tax can vary from 16% to 27% depending on the capital gain, depending on the amount of the capital gain and the income. But if a property is inherited, the capital gain is part of the entire estate, which could mean a higher tax rate on the estate, if there are many assets to include.
How to determine the fair market value?
Your assumption is correct: the FMV of the property would be used to determine the capital gains tax due whether you decide to buy the property or wait to inherit it.
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