If I am willed a house and prefer to sell my primary residence to move into the inherited house, do I pay capital gains tax on the sale of my house?
Is it better to be on title of the house I will inherit, even though I own another house, or leave it as an inherited house only to save taxes?
—Doris
Tax implications of inheriting a second property
When someone dies owning real estate, the tax consequences depend on whether the property was the deceased’s principal residence and whether any capital gain arose. In Canada, a death triggers a deemed disposition: the deceased is treated as having sold capital assets immediately before death. If the real estate qualified as the deceased’s principal residence for every year it was owned, that gain would generally be sheltered by the principal residence exemption and no tax would be payable by the estate on that property. If some or all of the capital gain is taxable, the estate is responsible for any tax owing on the final tax return filed for the deceased.
As a beneficiary, when you inherit real estate you generally receive it tax-free at the time of inheritance. The fair market value of the property on the date of death becomes your cost base for future capital gains calculations. That means any increase in value from the time you inherit the property until the time you later sell it may be subject to capital gains tax, unless an exemption applies.
For example, if you keep the inherited house and convert it into a rental, any appreciation from the date of inheritance to the date of sale will be part of the capital gain and may be taxable. If you use the inherited property as your personal home — for instance, as a primary residence or as a cottage that you ordinarily inhabit — you may be able to claim the principal residence exemption for the years you designate it as such, reducing or eliminating capital gains tax on that period of ownership.
What qualifies as a principal residence?
To qualify as a principal residence, the property must be ordinarily inhabited by the taxpayer during the year. That does not mean it has to be the place you live full-time or the address you list on your tax return; even short periods of ordinary habitation in a year can be sufficient. The Canada Revenue Agency looks at whether the property was ordinarily inhabited by the taxpayer in that year to determine eligibility for the exemption.
When you sell a property, or when you are deemed to have sold it (as at death), you claim the principal residence exemption on your tax return for the years you designate the property as your principal residence. Because only one property can generally be designated as a principal residence per family unit per year, owning multiple properties over overlapping periods can affect how much of the total capital gain is sheltered. For instance, if you owned one property for 20 years, then inherited another property and owned both for an additional 10 years before selling both, you could only designate one property per year. That may mean only a portion of the gain on the original property is sheltered.
What is the principal residence “plus one” rule?
If you sell your primary home in the same year you acquire or inherit another residence, there is a practical concession often referred to as the “plus one” rule. This allows two properties to be treated as the taxpayer’s principal residence and potentially qualify for the exemption in the year one residence is sold and another is acquired. In Doris’s situation, if she sells her existing home in the same calendar year she inherits and moves into the new house, she may be able to claim the exemption for both properties for that year, which could result in no capital gains tax on either property for those qualifying years.
How the transfer of ownership takes place
As for whether it’s better to have your name on title before the transfer or to wait until it is inherited, the practical point is that the executor of the estate handles title transfer as part of estate settlement. The estate must transfer legal title to the beneficiary named in the will or as required under law, so you typically do not have flexibility to take title in advance merely to manipulate tax outcomes. The property will be registered in your name once the executor completes the estate administration process.
In summary, it is possible to avoid capital gains tax on both properties in the scenario you describe if timing and principal residence rules align: namely, if your existing home qualifies as your principal residence for all years you owned it and you sell it in the same year you inherit and occupy the other home. If you do not sell in the same year, the inherited property’s future appreciation from the date you acquire it will create a new cost base and may be subject to tax on a later sale or on your own death. Because tax rules and personal circumstances vary, it is a good idea to discuss specifics with a qualified tax advisor or estate lawyer to confirm how the rules apply to your situation.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products.
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