Jack inherited a house in British Columbia when he was a young man. It was a lovely old house on a quaint old street and the perfect place to raise a family. Eventually, the children moved out and his wife died. He lived on in the house as a widower, tending the garden each year while growing older. When his health failed in 2003, he moved to Calgary to be with family, and after a few years in a "grampa suite" at his daughter's place, he went into a care home.
He died last year and his daughter, Corey, was his executor.
The house did not sit vacant while he was living outside of British Columbia. It was rented out to tenants and generated rental income. Better, it steadily increased in value. It was worth $1 million when he moved out. Over the first four years it was rented out, it more than doubled in value. By the time he died, eight years after vacating the house, the value had reached $3 million.
As executor, Corey was responsible for finalizing his taxes. She had no idea how complicated the tax filings would become. The first thing she learned was the change in use, from owner-occupied to rental, was actually a taxable event. The Canada Revenue Agency treats a change in use as if it were a sale, and capital gains would normally be triggered on the house. That was not a problem. Dad had a principal-residence exemption that would be available to shelter the capital gains up to the date he moved out. That exemption would erase any capital gains prior to the time he moved out. It left huge pent-up gains of $2 million for the years that followed, however. The taxes on that would be $400,000. She was not happy.
Her mood improved when her accountant suggested a better way to deal with it. The Income Tax Act allows a four-year grace period after a change in use. If available, it would allow the gain to be calculated as of 2007 rather than 2003. That deferral would save the estate $200,000 in capital-gains taxes. That would be great.
She then learned an election had to be filed at the time of the change in use. She went backwards through her dad's tax records to see if he had done it. No such luck. Her despair returned. The accountant did some research and discovered the election could be "late filed." That involved a special application that had to be sent in. There was a deadline: 10 years running from the date when Dad vacated. She was at year nine and just under the wire.
There was a penalty that might be charged to her dad's estate, but it came in at $8,000. That was a pittance compared to the taxes that would otherwise have to be paid. She also learned the penalty itself could be waived by the government in the right circumstances.
Everything worked out just right for Corey and her dad's estate. Who knew it could be so complicated? Corey and her accountant successfully bobbed and weaved through a complicated tax situation and, following the rules, saved $200,000.
What lessons do we take from this? First, her dad should have filed the election when he had the chance. Good accountants cost money, but they are worth it if you have assets. Her dad should have relied more heavily on accountants along the way. Perhaps you should, too.
Second, the executor of an estate is responsible for finalizing the tax filings for the deceased. If anyone needs a good accountant, it is an executor. The executor owes an obligation to the other heirs to get it right.
Taxes are complicated. This is not an area to scrimp on professional fees.
Third, we should keep careful records for our family, so the persons we name as executors can do the job right and do it easily when the time comes. For each house, cottage, or other recreation property, we should keep all of our receipts for capital improvements.
Corey still had to pay a capital gain on behalf of the estate in connection with her dad's house. The receipts allowed the capital gain to be reduced.
Jack and Corey are real. Names and details have been changed to protect their confidentiality.
John E. S. Poyser is a Winnipeg lawyer with the Wealth and Estate Law Group. Contact him at 947-6801 or firstname.lastname@example.org