Tax-wise estate transfers

The best thing advisors can do for bereaved clients is make the process of transferring assets stress-free and tax-efficient, writes Mike Connon

Tax-wise estate transfers

When we lose a family member, the loss is always keenly felt. We can find some comfort by at least minimizing wealth lost to taxes when transferring a loved one’s estate to a spouse or other heirs.  

I can illustrate one tax-wise strategy based on personal experience. A few years ago, my mother passed away, leaving behind a Florida investment property she and my father jointly owned. My father and I agreed it was time to sell it. He was in his 90s, and it was too much to maintain. Were it not for the burdensome capital gains taxes they expected to incur, they probably would have sold it long ago.  

As I was compiling information to complete my mom’s final tax return, I consulted with my parents’ accountant. He confirmed that the condo would pass tax-free to my dad. But according to the Income Tax Act, assets typically pass at their adjusted cost base to spouses and common-law partners.  

As such, if my dad sold the condo the following year for anywhere near its fair market value, we faced a problem: If the assets transferred at adjusted cost base, the capital gains on the sale would not be split between husband and wife. Instead, the entire capital gain would be added to the rest of my father’s annual income, which would put him close to the top marginal tax rate. He’d owe higher taxes on the entire taxable portion of the condo proceeds, as well as the rest of his income that year.  

This gave me an idea to run by my own accountant. I asked him whether we could transfer the condo to my dad at its fair market value instead of its adjusted cost basis. (An asset’s adjusted cost basis is essentially its original purchase price, adjusted for certain expenses or events along the way. Fair market value is basically what it’s worth today.) 

My accountant said there would be some extra paperwork, but it could indeed be transferred at fair market value by causing my mother’s estate to realize her spousal half of the capital gains on her final tax return. In light of her minimal income that year, these gains could then be subject to her lower marginal tax rates, while creating a significant tax savings for my father.  

If you’re following me so far, you may be wondering whether you could apply this same strategy to other assets. I wondered the same at the time, so I asked my accountant. He said yes, you could, although the Canada Revenue Agency does require you to submit a special tax election to specifically opt out of the adjusted cost base rollover. This brings me to my next illustration.  

About a year later, one of our elderly clients, whom I’ll call Jim, passed away. Jim had little income in the tax year of his passing and about $300,000 of unrealized capital gains in a joint account with his wife, ‘Jane.’  

We held a family meeting to discuss whether it might make sense to transfer the account to Jane at fair market value rather than its adjusted cost base, similar to the strategy I’d employed for my mom and dad. Doing so would cause the family to realize Jim’s $150,000 half of the gain on his final tax return. The gains would be taxed at his minimal tax rate, and we could ‘reset’ the adjusted cost base of the account to $150,000 when it transferred to Jane at fair market value.  

The family agreed that this made sense and proceeded accordingly. What if we had instead transferred the account at its adjusted cost base? Upon death, Jane would have ended up with all the income in her name with no ability to split it with a spouse. As such, when Jane passes, the taxes on the additional $150,000 of capital gains would probably have ended up being calculated at a much higher tax rate, as would other income on her final return.  

These particular strategies may or may not work for every family during every estate transfer, but it’s worth being aware of the possibilities. They also illustrate the value a financial professional can add, especially during major life transitions. The last thing families want to be doing when they lose a loved one is to fuss over the financials. But neither do they want to give up wealth unnecessarily. That’s what we’re here for – to offer objective financial advice with our clients’ best interests in mind.