Can we avoid capital gains tax?

A reader’s question highlights the implication of timing and disposition when it comes to how tax is calculated on an inherited property.

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Yesterday, I blogged about the difficulties regarding taxes owed on inherited property. Today, I’m going to answer a reader’s question that dives a little deeper into this topic, but highlights the importance of when a property is inherited and how quickly you decide to sell or change the use of that property (and the implications the timing of these decisions has on your taxable profit).

READER QUESTION: My wife & I live in an apartment in Vancouver. The apartment is owned 100% by me because it was bought before our marriage. Her mom owns a house in Edmonton, with a small home equity line of credit balance outstanding. What will happen to the tax situation when the mother passes away? My wife is the only child. Also, is it better to add her name to her mom’s property now? Any tax implication?

Great question and thanks for writing in to Home Owner: MoneySense.ca.

Since the Edmonton home is considered your mother-in-law’s primary residence there would be no taxes owing by the estate when your mother-in-law passes away. That’s because it’s the estate, not your wife, the inheritor, that’s responsible for capital gains taxes — and since a primary residence is exempt from capital gains tax, no taxes would be owed.

However, once the property is in your wife’s name the rules change. That’s because only a primary residence is tax exempt and, according to what you stated in your question, the Edmonton house cannot be considered her primary residence because:

  • She currently resides in her marital home (the home designated as the primary residence for a common-law or married couple, even if only one person is on title);
  • Only one residence may be considered a primary residence per family unit (the CRA tightened these rules about 20 years ago to prevent couples from splitting up real estate assets and claiming one property each as their primary residence);
  • Finally, your wife doesn’t live in Edmonton, Alta., nor will she reside in the Edmonton home for the vast majority of any calendar year.

What does all this mean? It means your wife would be subject to capital gains tax once she determines what she will do with the Edmonton house. From what I can gather, her choices are:

  • Rent out the property;
  • Sell the property;
  • Move into the property;
  • Do nothing and leave the property vacant.

I’m going to assume that the last two options are not really viable options.

That means you can either rent out the property or sell the property — and if either of these options are completed shortly after your wife inherits the property, then the tax implications are the same: she will be taxed on the difference between the fair market value (FMV) and the sale price.

If the inherited Edmonton home was appraised at $350,000 (at the time of inheritance), but your wife sold it for $400,000, she would owe capital gains tax on the $50,000 profit (the difference between the FMV and the sale price). If she sold it for less than $350,000 she would owe no tax as there was no profit.

Ask Home Owner columnist Romana King your real estate question »

However, if she opted to rent out the house (as an income property) she would still be subject to  capital gains tax — as the use of the property has changed and this change in use is what the taxman calls a “deemed disposition.” Just as if she sold the property, she would be taxed on the difference between the FMV and the sale price, only in this situation, the FMV and the “deemed disposition” sale price would be the same. Hence, she’d owe no tax as long as the FMV of the home was the same, or similar, to the FMV of the home when it’s use changed to a rental property. That also means that if there is a lapse in time she could be subject to capital gains tax. For instance, if the FMV of the inherited home is $350,000 and then six months later, when she rents the house, the appraised value is now $400,000, she would have to pay capital gains tax on $50,000. She would then have to pay additional tax when she sold the property. So, if she sold the property three years later for $450,000, she would either pay capital gains tax on $100,000 or $50,000 depending on how quickly she’d calculated the deemed disposition after the inheritence.

Keep in mind that capital gains are one of the more favourable taxable profits, when compared to other types of investment gains. For instance, income is 100% taxable at your  marginal rate (which increases as your income increases), where as interest income (on, say, bonds) is also subject to 100% taxation at your marginal tax rate. Only half of any capital gain you receive is subject to your marginal tax rate. That means if you sold the home for a $50,000 profit, you’d only be taxed on $25,000.

I hope this helps, although I strongly suggest you seek out legal and/or financial expertise before launching into any plan of action.

19 comments on “Can we avoid capital gains tax?

  1. Isnt there a possibility of transfering the property into a Trust

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  2. Hi Joe,
    Yes. It is possible to put real estate holdings (or other assets) into a trust, but you'll need to be clear as to why you're using a trust. Typically trusts are used to avoid probate, but in Canada real estate left in a will to an heir is not subject to probate fees, so a trust (along with its legal fees) is not necessary. Also, from what I'm told, a trust wouldn't negate capital gains taxes owed by the deceased's estate. It would simply transfer the taxes owing from the deceased's estate to the trust — but the taxes would still be owed. Again, though, there's a lot of complexity to estate planning and taxes. For more specific advice seek out a legal and/or financial expert.
    Thanks!
    Romana

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  3. You can also avoid capital gains tax by selling it at a loss.

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    • Yes, but you are better off selling for FMV and paying the tax on the capital gain than you are taking a loss just to avoid the tax.

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  4. How is the tax calculated on that $25,000?

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  5. @m3kw: Be careful if you try and sell a property at a loss. If the CRA suspects that the sale was to avoid paying capital gains they'll expect payment based on the fair market value (FMV) of the property!

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  6. @Deirdre: You pay a capital gains tax based on the difference between the purchase price and the selling price. If, for instance, you purchase a property for $100,000 and then sold it for $200,000 the profit of $100,000 would be subject to capital gains tax. Now, the benefit of this particular tax is that only HALF of your profit is actually subject to tax. On our example, you would pay tax on $50,000. The actual tax rate is your marginal tax rate, based on your taxable income. Hope this helps!

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  7. i have lived and worked in a city in southern alberta for 17 years and my wife has lived and worked in
    another city in southern alberta where she has worked full time for 14 years. We own two houses , one in each city.
    Can we not be understood to have two principal residences ?

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  8. My husband and I are selling an apartment that our daughter lived in. (She moved out as she bought her own place elsewhere.) Do we pay capital gains on the apartment sale? Our daughter just lived there, we did not charge her rent.

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  9. My husband and I got married in the Fall 2011. We each owns a house as principal residence, purchased a few years before. For logistical reasons (my house location meets kids schooling needs and my husband's satisfies elderly accommodation requirements). We are planning to build or buy a new house that would satisfy both needs. In the meantime, it is more convenient to keep both houses. Would one of the houses be subject to capital gains even if it is for personal use? What are the financial implications if we were to keep both houses for the next two years (for personal use only)?

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  10. I reneted out part (45%) of my principal home. when i filed my income tax return, i report rental income & expences (Except CCA) When i check online in "My Account" there is carryforward amount of Net rental income (Gain). I did not do any structural changes in my principal property.
    If i will sell this property in future for higher then my purchase price, Do i have to pay capital gain tax ?
    Please answer me. I am really confused. Thanks.

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  11. I reneted out part (45%) of my principal home. when i filed my income tax return, i report rental income & expences (Except CCA) When i check online in "My Account" there is carryforward amount of Net rental income (Gain). I did not do any structural changes in my principal property.

    Reply

  12. We purchased a home in 1999 for $119K and spent approx $50K in renovations. Now, it's appraised at $350K and we've since moved to another home and are allowing our kids to live at that property while they save for a home of their own. When we go to sell that house, will the capital gains amount be the difference between 119K – 350K= $231 OR 119K + 50K – 350K = $181K? If it's the difference between 119K and $350K, is there some way to recoup the $50K in renovations?

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  13. We bought a town house in 2003 as our principal residence for 204,000 . In 2008 we have it asssed and the value is 260',000. We bought another property in same year in 2008 and have the townhouse rented out. If i am going to sell now the townhouse for 300,000 how much capital gain tax i have to pay considering i lived their for five years as my principal residence.

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  14. I have moved to another province but have not sold my residential property yet. If I buy a new 2nd property, how much time do I have to sell my first property to avoid paying tax on the capital gain?

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  15. I purchased land in 1977 for 7,000. Built a house and moved in 87. It's been rented ever since. It's now assessed at 177,000. If I sell how much tax would I pay?

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    • In your case you have a lot of things going against you. From 1977 to 1987 is probably when most of the increase in value of the property occured since you basically built a house on vacant land, but you probably don't have any evidence or records of that increase in value or how much it cost you (e.g. cost of building materials, labor expenses), nor did you do a deemed disposition during the change in use. You may not even have properly reported your rental income.

      All of these combined means the only thing you can prove to the CRA is that it costs you $7000 to acquire the property and it's now worth $177,000, and they're going to want you to pay taxes on the difference. Then, if you didn't report your rental income properly, they're going to force you to pay taxes on that, plus interest for late payment, plus penalties for not reporting properly.

      Find a professional who knows what they are doing and who can work with CRA to minimize your tax liabilities here. But get a quote first, as hiring professionals doesn't always get you your moneys worth!

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  16. My Father bought a 1/2 duplex in Edmonton in 1979. He put his girlfriend and myself on the title, we were all joint owners, I was 19 at the time and living with them. I later moved out when I married, my father and his girlfriend were married in 1986. My father passed away in January of 2015, so that left his wife and I each a 50-50 ownership. His wife and I don’t get along so she went to court to disolve the ownership and place it in tenants in common, so she took half of her half and sold it to her neice for $1.00. I don’t want to deal with a stranger over my fathers house so told my lawyer I would like for the wife and niece to buy me out, so my lawyer is working on that right now. What happens after that is finalized? Thank you for your help

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  17. looking for how two parents can sell their cottage (second home) and not pay capital gains ….assumed they sell before they both die. Principal residence(other home) will have no capital gains when it’s sold upon death of both, as it’s the principal residence.

    Reply

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