On April 16, 2024 the Canadian Federal Government issued its 2024 Budget that announced key changes in taxation coming into effect on June 25, 2024. These changes particularly impact the taxation of estates and will likely have a profound impact on estate/succession planning for both Canadian residents and non-residents with investments/assets located in Canada going forward.

Taxes Imposed By The Canadian Federal Government Following Death

Unlike the United States, the Canadian federal government does not impose an estate tax; namely, a tax on the value of assets owned at death. Instead, subject to certain exceptions, taxpayers are deemed to have disposed/sold all of his or her assets at fair market value at death.[1] This in turn imposes capital gains on all of an estate’s capital assets which triggers an income tax liability. For those who are not Canadian residents, these deemed disposition rules apply to the non-resident’s capital assets located in Canada (ex. vacation homes, rental properties, Canadian business interests etc.). 

Similar Deemed Disposition Rules Also Apply in Several Other Circumstances Including:

• When assets are transferred by gift;
• When assets are transferred into trusts;[2]
• When a person emigrates from Canada;[3] 
• Upon every 21st anniversary of the date assets are transferred into a trust.[4] 

There are several exceptions to the above deemed disposition rules, so it is imperative to seek advice from qualified professionals in order to effectively navigate this taxation regime.

These capital gains rules differ substantially from the United States where assets are subject to a step-up (or step-down) in capital gains basis. In this regard, assets included in a US gross taxable estate are deemed to have a capital gains basis equal to the fair market value of those assets at the time of death. Often this is a significant tax benefit that can often be taken advantage of with proper planning. 

Changes To The Capital Gains Inclusion Ratio

For over twenty (20) years, a fifty percent (50%) inclusion ratio was applied to all capital gains, whether arising from sales or the various Canadian deemed disposition rules. This means that half of the capital gains are considered taxable income and subject to tax. 

For example, if a cottage located in Canada was originally purchased at the price of $100,000 and then at death the fair market value of that cottage had appreciated to a value of $1,000,000, fifty percent (50%) of the $900,000 gain ($450,000) would be subject to tax. In such a scenario, the estate is deemed to have earned an additional $450,000 in taxable income triggering a tax liability of approximately $225,000 following death. 

However, effective June 25, 2024, the capital gains inclusion ratio will increase to two-thirds (66.67%) for all gains in excess of two hundred fifty thousand dollars ($250,000.00).[5] Therefore, using the same fact scenario described above, if the decedent died on or after June 25, 2024, two-thirds (66.67%) of the gain will be included in the estate’s taxable income ($600,000) if at least $250,000 in gains are realized by the estate elsewhere. In this scenario, the estate would incur a tax liability of over $320,000, a considerable increase from the tax rates in effect since 2001. 

The Potential Tax Consequences in Each Scenario Described Above Are Illustrated in the Charts Below:

Potential Capital Gain Consequences Before June 25, 2024
Tax Basis In Cottage	$100,000
Fair Market Value at Death	$1,000,000
Total Gain:	$900,000
Inclusion Ratio	50%
Approximate Income Tax	$225,000

Potential Capital Gain Consequences Before June 25, 2024
Tax Basis In Cottage	$100,000
Fair Market Value at Death	$1,000,000
Total Gain:	$900,000
Inclusion Ratio	66.67%
Approximate Income Tax	$320,000

*Please note that the approximate calculations above are based on an assumption that at least two hundred fifty thousand dollars ($250,000) in gains were realized by the estate elsewhere. Otherwise, the 50% inclusion ratio would apply for the first $250,000 of gains realized upon the deemed disposition of the cottage. *

Impact On Canadian And Cross Border Estate Planning

As the change in the capital gains inclusion ratio comes into effect on June 25, 2024, it is expected that many will intentionally trigger the anticipated gains, through gifting or other mechanisms, prior to the higher inclusion ratio coming into effect. However, the rush to trigger gains early will be short lived, as different strategies will need to be employed to minimize capital gains taxation going forward. 

As the increase in the inclusion rate after June 25, 2024 only applies for gains in excess of $250,000, estate planners may seek to implement various strategies to take advantage of lower tax rates by intentionally triggering gains of up to $250,000, through gifting or otherwise, on an annual basis to limit the anticipated tax liabilities following death. Employing any of these strategies can be a complex matter and it is imperative that the tax and practical consequences of any gifting or other strategy are carefully considered after obtaining advice from qualified professionals. 

These issues can face further complications in the context of cross-border estate planning. For example, if the owner of the cottage in the above scenario is an American citizen or domicile, any gift of an interest in the Canadian cottage/vacation home will likely cause a taxable gift in the United States thereby triggering reporting requirements and tax of up to forty percent (40%) on the value of the interest gifted.[6] Moreover, if any portion of the interest in the Canadian cottage is transferred to the donor’s grandchildren, then United States Generation Skipping-Transfer Tax could also be triggered, which could not only cause additional taxation, but may also impact carefully established estate plans in the United States.[7] It is therefore important to seek legal counsel well-versed in every jurisdiction in which you hold assets to ensure any estate/succession plan is coherent with the tax laws applicable in each jurisdiction. 

Conclusion

Following June 25, 2024, the capital gains consequences following death will substantially change for both Canadians and non-residents who hold assets located in Canada. As these changes can significantly impact the tax consequences of estate and succession plans, it is important to seek the advice of an attorney to assess whether updating the existing plan is warranted and advisable.

It is expected that Canadian estate plans will adapt to employ various strategies to make full use of the lower capital gains inclusion ratios applicable to gains under $250,000. However, careful consideration is necessary for those with assets in multiple jurisdictions, as changing the structure of an estate plan in Canada could impact the tax consequences in other jurisdictions.

Estate planning, especially for those with assets in multiple jurisdictions, is a complex matter. Changes in laws and personal circumstances may render an existing estate plan inappropriate or disadvantageous. The recent changes to the Canadian capital gains inclusion ratio illustrate the importance of regularly reviewing existing estate plans with an attorney in each jurisdiction in which you reside or hold assets.

If you need assistance please call our attorney Andrew Nutbrown who is licensed to practice in both Canada and California. Mr. Nutbrown can be reached at: (626) 565-5680 ext. 109

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[1] Income Tax Act RSC 1985, c 1 (5^th Supp), s 70(5)(a).

[2] Income Tax Act RSC 1985, c 1 (5^th Supp), s 69(b).

[3] Income Tax Act RSC 1985, c 1 (5^th Supp), s. 128.1(4).

[4] Income Tax Act RSC 1985, c 1 (5^th Supp), s 104(4).

[5] Budget 2024: Fairness For Every Generation: https://budget.canada.ca/2024/report-rapport/toc-tdm-en.html

[6] 26 US Code §2501.

[7] 26 US Code §2601.