Losing a spouse can be both sad and overwhelming. However, having a good understanding of the tax consequences associated with the transfer or disposition of their assets may make this difficult time less daunting. Talk to your BDO advisor who can help you navigate your way through this distressing time.
Published: June 25, 2024
Updated: June 25, 2024
As discussed in Part I of this article, in addition to the sadness of losing a loved one, a surviving spouse or partner is often faced with difficult decisions and sorting out their loved one’s financial affairs. This can be overwhelming especially in circumstances where the deceased individual owned different types of property. This article addresses the tax consequences associated with the transfer or distribution of a spouse’s or common-law partner’s property following their death. Please note that for the balance of this article, all references to the term ‘spouse’ includes common-law partners.
Distribution of property
The legal representative of your deceased spouse has several key income tax related responsibilities. Among them is the requirement to inform beneficiaries which of the amounts they receive from the estate are taxable. You should note that the tax treatment of property and assets owned at the date of death can be complex. While it is important to have a good understanding of the following income tax consequences that may arise as a result of your spouse’s passing, it is beneficial to consult your BDO advisor before any distributions are made.
Capital property
Generally, there will be a deemed disposition of your spouse’s capital property (which includes securities, such as stocks, bonds, units of a mutual fund trust, and real estate) at fair market value (FMV) immediately before their death. Of notable importance, there is an exception to this rule in cases where capital property is left to you or to a qualifying spousal trust. In this circumstance, any capital gain or loss is deferred until the transferred property is disposed of by either you or the spousal trust. Keep in mind that the estate’s legal representative may elect to have the transfer from the deceased individual to a surviving spouse take place at FMV. There may be significant tax advantages to making this election if your spouse owned shares in a qualified small business corporation or qualified farm or fishing property or had capital losses that had not yet been utilized immediately before their death. Also, if your deceased spouse’s taxable income in the year of death is low, perhaps because they passed away early in the calendar year, it can be advantageous to make a transfer of capital property at FMV.
RRSPs
Upon death, your spouse will be deemed to have collapsed any Registered Retirement Savings Plans (RRSPs) that they may have. Similar to the treatment of capital property noted above, your spouse will be taxable on the FMV of the plan(s) at that time. However, if you are the beneficiary of your spouse’s RRSP, the value of the RRSP can be included in your income instead of being included on your deceased spouse’s final tax return. You can then transfer the value of the RRSP to your own RRSP and you will not have to pay any tax on these funds until you withdraw the funds from the plan.
You should note that there are special rules that may apply if your deceased spouse has designated a financially dependent child or grandchild as the beneficiary of their RRSP. If this is the case, consult with your BDO advisor. If your spouse held a Registered Retirement Income Fund (RRIF) at the time of their death, similar rules apply.
Contributions to a Tax-Free Savings Account (TFSA), along with any income earned on the amounts contributed, accumulate tax free. Furthermore, these amounts are not taxable when withdrawn from the TFSA. However, earnings that accrue following the death of the holder of the TFSA are taxable. Having said that, it is still possible to maintain the tax-exempt status of the earnings of the TFSA if your spouse named you as the “successor holder” in the TFSA contract. Keep in mind that doing so will not affect your TFSA contribution room. Also, you would be considered to be the holder of two separate TFSA accounts if, after taking over ownership of your deceased spouse’s TFSA, you already have your own TFSA. In this circumstance, you are permitted to directly transfer part or all of the value from one TFSA to the other TFSA without affecting your TFSA room. Don’t forget that a successor holder designation is effective only if it is recognized under applicable provincial and territorial law.
If you are not a successor holder, but instead are a designated beneficiary of the TFSA, payments out of your deceased spouse’s TFSA can be transferred to your TFSA without affecting your unused TFSA contribution room, subject to certain conditions and limits. In particular, this contribution cannot exceed the fair market value of the deceased spouse's TFSA at the time of death.
The new First Home Savings Account (FHSA) is a registered account that offers prospective first-time home buyers the ability to save funds on a tax-free basis to purchase a home within 15 years. FHSAs are similar to RRSPs in that the contributions are tax deductible. FHSAs are also similar to TFSAs in that withdrawals to purchase a qualifying home, as well as any income and gains earned within the account, are not taxable.
Like a TFSA, you may have been designated as a “successor holder” of your deceased spouse’s FHSA, where provincial or territorial laws permit. If this is the case and you are a qualifying individual (i.e. eligible to open a FHSA), you will become the new holder of your deceased spouse’s FHSA, subject to certain conditions. This generally means that there will be no immediate tax consequences and your annual and lifetime limit will not be impacted. If you are not a qualifying individual (i.e. not eligible to open a FHSA), you can either transfer the amount to your RRSP or RRIF by the end of the year following death or receive a taxable distribution. Similarly, if you are not designated as a successor holder but are designated as a beneficiary under the terms of the FHSA or under the terms of your spouse’s will, you may be able to transfer the amount to your FHSA, RRSP, or RRIF by the end of the year following death or receive a taxable distribution. If you are not the beneficiary, distributions from the FHSA to the beneficiary are generally included in the beneficiary’s income for tax purposes.
In situations where there are no designated beneficiaries, the amounts from the FHSA will be distributed to your deceased spouse’s estate and included as income. However, if you have a beneficial interest in your deceased spouse’s estate, you may still benefit from a tax-free transfer where you and the legal representative of your spouse’s estate make a joint election and satisfy certain conditions. Alternatively, you and the legal representative may also jointly elect to transfer the payment to be a taxable distribution.
The information in this publication is current as of May 27, 2024.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.