You’ve inherited a home: do you owe tax?

It’s common practice in Canada for parents or grandparents to leave their home or cottage to a child or grandchild. It’s also common practice for the taxman to expect a share of the transfer proceeds, as the value of the property has now transferred from owner to another.

One exception is if a surviving spouse or common law partner inherits the property, then no tax is owed on the transfer of the estate.

Inheriting a secondary residence

In general, however, when a piece of property is bequeathed it may subject to tax, if the property was not a principal residence.

That means if you inherit your parent’s cottage — a vacation home not designated as a principal residence — then the transfer of ownership would be subject to tax. This tax is calculated as if the cottage had been sold at a fair market value.

Under Canadian tax law, the taxes on this transferred cottage property are owed by your parent’s estate (not by the person inheriting the estate).

But, if the estate is cash-poor and property rich, you might find yourself taking out a loan or selling assets in order to come up with the estate taxes owing.

Inheriting a primary residence

On the other hand if the bequeathed property has been a principal residence, your parent’s estate would not be subject to capital gains tax on the disposition of the property.

However, if you were to sell your parent’s principal residence — say, because you already have a home — the sale would be subject to capital gains tax, since you’re selling a piece of property that is not your primary residence.

Sell the house shortly after you inherit and you’ll find the capital gains tax will be nominal, as there will be little difference between the assessed fair market value that was done when you inherited the property and the sale price.

Multiple owners

Of course, all this gets a lot more complicated when you have multiple owners.

Say, for example, your parents leave their primary residence to you and your two sisters. As siblings, you make a unanimous decision to allow the youngest to move into the home and to take out a mortgage to buy out the other two siblings.

Since the youngest now considers the inherited property as their primary residence, they won’t be subject to tax.

The other two siblings, however, would have to pay capital gains tax once the youngest child has moved into the home. That’s because the change in use of the home triggered what the taxman calls a “deemed disposition”— the use of the home has changed, and thus the home is considered to have been sold for tax purposes.

FMV is the key

The best way to determine what’s owed and when is to pay for an independent fair market value (FMV) assessment of the property whenever you anticipate a change in the property’s use.

That means:

• If you plan on selling your parent’s primary residence, you need to get a FMV price, so you can calculate the capital gains you will owe (subtract the sale price from the FMV price and you’ll know how much you’ll owe tax on);
• If you plan on renting out the property, instead of selling, you will also need to know the FMV. Because you are changing the use of the property — from primary residence to investment property — the taxman considers the property sold, for tax purposes. That means, you’ll theoretically owe capital gains tax on the difference between the value of the inherited home and the FMV of the home when you chose to start renting it out.
• If multiple people inherit the home and one child decides to buy out the other siblings, you’ll need to establish a FMV price not only to determine the buy-out price, but also to determine how much tax is owed on the deemed disposition of the property.

An independent assessment of your property should cost no more than $1,000 (and typically starts at $350). Given how much you could save in taxes this fee is a nominal expense.