Electing Out of Spousal Rollover on Death: A Guide

Introduction

In Canada, when a taxpayer passes away, the Income Tax Act (ITA) deems all capital property owned by the deceased to be sold at its fair market value (FMV) immediately before death. This results in the realization of any previously unrealized capital gains or losses, with the tax implications reported on the deceased’s final T1 tax return. However, when property is transferred to a surviving spouse, spousal rollover rules allow for tax deferral. This article explores the mechanics of spousal rollover and the circumstances under which electing out of this automatic treatment can be a beneficial estate planning strategy.

What is a Spousal Rollover on Death?

A spousal rollover provides tax deferral when a surviving spouse inherits property from a deceased spouse. Instead of the property being deemed sold at its FMV, it is deemed sold at its adjusted cost base (ACB) or cost to the deceased. The surviving spouse acquires the property at the same ACB, inheriting any unrealized gains or losses.

Key Features of Spousal Rollover:

• Automatic Application: The spousal rollover applies by default when property is transferred to a surviving spouse.
• Tax Deferral: The capital gains tax on the property is deferred until the property is sold or the surviving spouse passes away.
• Broad Application: The spousal rollover applies not only on death but also to transfers between spouses during their lifetime.

This treatment is generally advantageous for properties with significant unrealized gains, as it allows tax deferral, providing the surviving spouse with more liquidity to invest or manage the property.

Electing Out of the Spousal Rollover

The executor of the deceased’s estate has the option to elect out of the spousal rollover for specific properties. This election must be made on the deceased’s final T1 tax return and applies on a property-by-property basis. However, it cannot be partially applied to a single property.

When to Elect Out of the Spousal Rollover?

Electing out of the spousal rollover may be beneficial in certain scenarios, including:

1. Utilizing the Lifetime Capital Gains Exemption:
   • If the deceased held property eligible for the Lifetime Capital Gains Exemption (LCGE), the executor could elect out to realize gains and apply the exemption, avoiding tax while increasing the adjusted cost base for the surviving spouse.
2. Offsetting Unused Capital Losses:
   • The deceased may have unused capital losses from prior years. By electing out, gains can be realized to utilize these losses without incurring additional tax liability.
3. Crystallizing Capital Losses:
   • Electing out can also crystallize capital losses, which can be carried back to offset gains reported in previous years, potentially resulting in a refund for the deceased’s estate.
4. Adjusting the Cost Base for Future Tax Efficiency:
   • By realizing gains or losses now, the property’s cost base increases for the surviving spouse, potentially reducing future taxable gains upon disposition.

How to Elect Out:

• The election is made by filing the appropriate forms with the deceased’s final T1 tax return.
• The executor retains full control over this decision and does not require consent from the surviving spouse.

Tax Implications of Electing Out

Electing out of the spousal rollover subjects the property to the default rules of the ITA:

1. The property is deemed sold at its FMV immediately before death.
2. Any resulting gains or losses are reported on the deceased’s final T1 tax return.

Benefits:

• Realizing capital gains can strategically offset unused exemptions or losses.
• Crystallizing losses can provide immediate or retroactive tax relief.

Drawbacks:

• Immediate tax liability may arise if no offsets (like the LCGE or unused losses) are available.

Pro Tax Tips for Estate Planning

1. Engage in Preemptive Planning:
   • Plan well in advance to evaluate whether electing out of the spousal rollover is beneficial. This includes reviewing the deceased’s and surviving spouse’s tax positions.
2. Leverage the Lifetime Capital Gains Exemption:
   • For qualifying properties, such as shares in a Qualified Small Business Corporation (QSBC), using the LCGE can eliminate tax on realized gains.
3. Document Decisions:
   • Ensure all elections are clearly documented and supported by accurate valuations and records.
4. Consult with Professionals:
   • Estate planning is complex and requires careful consideration of all variables. Work with a Canadian tax lawyer or accountant to optimize outcomes.

FAQs

What is the Spousal Rollover on Death?

The spousal rollover defers capital gains tax on property inherited by a surviving spouse, with the property transferred at its adjusted cost base.

When Should an Executor Elect Out of the Spousal Rollover?

Electing out may be advantageous if the deceased has unused capital losses, eligibility for the LCGE, or when the estate seeks to increase the cost base of the property for future tax efficiency.

Who Decides to Elect Out?

The election is made by the executor of the deceased’s estate and does not require the consent of the surviving spouse.

Conclusion

The spousal rollover is a valuable tax-deferral mechanism that applies automatically on the death of a spouse. However, electing out of this treatment can offer significant tax advantages in certain circumstances, such as utilizing capital losses or exemptions. Proper estate planning is essential to achieving the best outcomes. Executors and beneficiaries should seek professional advice to navigate these decisions and ensure compliance with Canadian tax laws.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

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