Electing Out Of Spousal Rollover On Loss of life: Toronto Tax Lawyer Information – Tax

Canada:

Electing Out Of Spousal Rollover On Death: Toronto Tax Lawyer Guide

20 August 2021

Rotfleisch & Samulovitch P.C.

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Background: The Death of a Taxpayer – Electing Out of the

Spousal Rollover on Death

When a Canadian tax resident taxpayer passes away, he or she

is deemed by the Income Tax Act to have sold all of his or

her capital property for its fair market value immediately prior to

his or her death. This has the effect of realizing all of the

deceased taxpayer’s previously unrealized capital gains and

losses. Any person who then inherits property from the deceased

taxpayer is deemed to have acquired that property for its fair

market value as of immediately prior to the taxpayer’s

death.

The deceased taxpayer’s executor is required to file a final

T1 personal tax return on behalf of the deceased taxpayer. The

taxation period covered by the final return begins on January 1 of

the calendar year in which the taxpayer passed away and ends on the

day the taxpayer passed away. As the deemed sale of the deceased

taxpayer’s property is deemed to happen immediately prior to

death, the income or loss from the deemed sale is reported on the

deceased taxpayer’s final T1 tax return.

The taxpayer’s estate will also need to file income tax

returns for the duration of its existence and pay tax on the income

it earns. The first day after the taxpayer’s death is the first

day of the first tax year of the estate. Some estates that do not

earn income or distribute property to their beneficiaries may not

be required to file tax returns.

Under Canadian income tax law, an inheritance is not taxable

income. So, the recipients of an inheritance do not pay Canadian

income tax on property they inherit. Any tax liability is incurred

by the estate of the deceased taxpayer.

The Spousal Rollover on Death – Electing Out of the Spousal

Rollover on Death

If an individual receives property from his or her spouse

because of the spouse’s death, then by default a different set

of rules apply which prevent any accrued gains or losses on that

property from being realized. Instead of being deemed to sell the

property at its fair market value, the deceased taxpayer is deemed

to have sold his or her that property at its cost to the

deceased’s spouse. This means that the deceased taxpayer will

not realize any gains or losses with respect to that property. The

surviving spouse will then be deemed to have acquired the property

he or she inherits at the property’s cost amount to the

deceased spouse. As such, immediately after receiving the property,

the surviving spouse will have the same set of unrealized gains and

losses as the deceased taxpayer had immediately prior to his or her

death. A transaction with this type of tax deferral treatment is

generally called a “rollover” and specifically in this

case is referred to as a spousal rollover. Note that a spousal

rollover is available on any transfer between spouses, not just as

a result of death.

This spousal rollover treatment is normally beneficial when the

deceased spouse had unrealized capital gains on the property

transferred. This is because the rollover defers the payment of

income tax on the capital gain until a later date, being the actual

sale of the property or the death of the surviving spouse. Unless

the property declines in value at some point in the future,

eventually the property will be sold or otherwise disposed of which

will result in the gain that existed at the time of the deceased

spouse’s death being realized and taxed. However, if the

requirement to pay tax is pushed further into the future, the

relevant taxpayer can invest and earn a return on the amount that

would otherwise be needed to pay the tax. This type of tax benefit

can be substantial if the unrealized gain is large or the property

is not sold by the surviving spouse for many years. Tax deferral is

a basic and important tax planning technique.

Electing Out of the Rollover – Electing Out of the Spousal

Rollover on Death

The spousal rollover treatment for property received by a

surviving spouse as a consequence of the death of his or her spouse

applies automatically. It is however possible to opt out of the

rollover treatment if the deceased spouse’s executor files a

corresponding election with the deceased spouse’s final return.

This election can specify on a property by property basis which

property should receive spousal rollover treatment or not. The

election cannot be partially applied to a single property. The

decision to file the election is in the control of the deceased

taxpayer’s executor. The executor does not require the consent

of the surviving spouse to make the election and the surviving

spouse cannot otherwise control whether the election is made.

Property to which the election is applied will receive the

default treatment described in the first section of this article

(e.g. deemed to be sold at fair market value immediately before

death). Despite the potential deferral advantages of rollover

treatment, sometimes it is better for the estate of the deceased

taxpayer to consult with an expert Canadian tax lawyer in order to

realize a capital gain or loss, and hence for the executor to file

the election. One example is if the deceased held property eligible

for the lifetime capital gains exemption (IT1) , in which case it

could make sense to make the election so as to make use of the

exemption. Another possible example is a situation where the

deceased spouse has substantial unused capital losses from previous

tax years. That could allow some gains to be realized without

additional tax payable, which would give the surviving spouse a

higher cost base in the property they receive and use up the

capital losses that might otherwise become useless. Crystallizing

capital losses by electing out of the spousal rollover may also be

useful if there are capital gains in prior years that can be offset

by carrying back the crystallized capital losses.

Pro Tax Tips – Electing Out of the Spousal Rollover on

Death

With proper estate planning, including evaluation of whether to

elect out of the spousal rollover on death, it is often possible to

achieve a substantially better tax outcome. It is essential to

consult with an experienced Canadian tax lawyer regarding

estate planning and administration of the estate of a deceased

taxpayer to ensure the best possible tax outcome.

The content of this article is intended to provide a general

guide to the subject matter. Specialist advice should be sought

about your specific circumstances.