What Happens to Your Taxes When You Die – A Complete Guide by a Montreal CPA Firm Near You

Introduction

When a person dies in Canada, their tax situation does not end quietly. Instead, the Income Tax Act triggers several important tax events, including a deemed disposition of assets, a final tax return, potential capital gains, and special rollover rules. Understanding what happens tax-wise at death is essential for families, executors, and individuals preparing their estate plans. The good news is that Canada does not have an inheritance tax—beneficiaries generally receive assets tax-paid. However, the estate may owe significant taxes before distributions can be made. This guide explains exactly what happens to your taxes when you die and how to plan for it.

Legal and Regulatory Framework

When someone dies, Canada triggers a deemed disposition under section 70(5) of the Income Tax Act. This means that, for tax purposes, the deceased is treated as if they sold all capital property at fair market value immediately before death. The deceased person’s executor must file the Final T1 Return, covering January 1 to the date of death. Additional optional returns—such as the Rights or Things Return or Business/Partnership Returns—may reduce tax if eligible. Unlike in some countries, there is no estate or inheritance tax. Instead, any tax owing is based on the final income and deemed disposition.

Key Court Decisions

In Somerville v. Canada, CRA reassessed an estate for failing to report deemed dispositions properly, reinforcing executor responsibilities. In Henderson Estate v. Canada, the court clarified the application of rollovers to spouses. In Daishowa-Marubeni v. Canada, the Supreme Court emphasized the valuation principles used in determining fair market value on deemed dispositions. These cases demonstrate that estates must carefully calculate asset values and follow the Income Tax Act’s death-related rules.

What Happens at Death for Tax Purposes

At the moment of death, CRA treats the individual as if they sold all capital property—such as real estate, cottages, rental properties, stocks, businesses, and cryptocurrency—at fair market value. This often triggers capital gains. Registered accounts such as RRSPs and RRIFs are fully taxable as income on the final return unless transferred to a spouse or financially dependent child. Non-registered assets may produce taxable gains. TFSA balances pass tax-free but stop earning new contribution room. Employment income up to the date of death is reported on the final return. The estate becomes a separate taxpayer immediately after death.

Spousal Rollover Rules

Canada allows capital property and registered accounts to transfer tax-free to a surviving spouse or common-law partner. This is known as the spousal rollover under section 70(6). Assets transfer at adjusted cost base, deferring the tax until the spouse sells or passes away. RRSPs and RRIFs can transfer tax-free if the spouse is named as beneficiary or if the estate elects the proper rollover. Without a spouse, capital gains and registered account income become taxable on the final return.

No Inheritance Tax in Canada

Beneficiaries do not pay tax on what they receive. Instead, the estate pays any capital gains tax triggered by the deemed disposition. Once taxes are paid, the executor can distribute assets without tax consequences for beneficiaries (except very specific situations like RRSPs left to non-spouses without a rollover).

Optional Returns to Reduce Taxes

Executors can file additional returns to reduce tax:

• Rights or Things Return for items such as unpaid employment income or dividends declared but not paid

• Business or Farming Returns for certain business income

• Return for Partner or Proprietor for certain partnerships
  These optional returns allow income splitting across multiple returns and reduce marginal tax rates.

Estate as a Separate Taxpayer

After death, the estate itself becomes a trust and may need to file T3 Estate Returns annually. For the first 36 months, the estate may qualify as a Graduated Rate Estate (GRE), benefiting from marginal tax rates. After 36 months, the estate is taxed at the top marginal rate unless it ceases to exist.

What About Real Estate?

If a home qualifies as a principal residence, capital gains may be tax-free. If the deceased owned a cottage or rental property, capital gains tax is often triggered at death unless rollover applies. Executors must obtain fair market valuations for all real estate to calculate capital gains accurately.

Executor Responsibilities

Executors must: file all required tax returns, obtain valuations, pay all taxes from the estate before distributing assets, resolve CRA audits if needed, manage trust income, and finally request a CRA Clearance Certificate to avoid personal liability. Without a clearance certificate, executors may become personally responsible for unpaid tax.

Mackisen Strategy

At Mackisen CPA Montreal, we guide families and executors through every tax requirement at death. We prepare the final return, optional returns, T3 estate returns, determine fair market values, apply the spousal rollover, optimize tax positions, coordinate with lawyers, prepare clearance certificate requests, and resolve CRA inquiries. Our goal is to minimize taxes, prevent penalties, and simplify the estate administration process.

Real Client Experience

A Montreal estate with multiple rental properties faced large deemed disposition taxes; we structured the estate to minimize capital gains using optional returns and accurate valuations. A family unaware of RRIF rollover rules avoided a large tax bill after we corrected beneficiary designations. An executor facing CRA audit for missing documentation was protected after we reconstructed valuations and filed proper returns. Another estate avoided probate delays after we secured the Clearance Certificate efficiently.

Common Questions

Do beneficiaries pay tax on inheritance? No—tax is paid by the estate. Are RRSPs taxable at death? Yes unless transferred to spouse or dependent child. What if the deceased owned foreign assets? Those may trigger foreign capital gains tax and must still be reported in Canada. Must the estate file annual returns? Usually yes—until the estate is wound up.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps families and executors navigate the complex tax rules that apply at death. We ensure compliance, minimize taxes, and protect executors from legal and financial risk.