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Handle deceased's home properly

Moving to a new home could present a great opportunity to get rid of all the junk you've accumulated over the years. And if you truly believe that myth, you probably haven't moved in an awful long time.

From what I can tell, moving doesn't eliminate junk; it simply repackages and rearranges it. Those trinkets that used to be sitting on a shelf in our family room collecting dust prior to our last move were suddenly transformed into randomly packed objects occupying 107 boxes, all marked "BASEMENT."

Fifty years from now, my grandkids will no doubt clean out my home and wonder why in the world I kept 17 orphaned socks in a box for two generations. These were the thoughts that crossed my mind as I searched our basement this week for our Halloween decorations stored in a box somewhere among the sea of boxes downstairs.

When my wife, Carolyn, and I are gone, our descendants will have to decide what to do with all this stuff. But it's not just my box of 8-track tapes that they'll have to deal with. They'll also have to make a decision about what to do with our home when we're gone. The principal residence of a deceased family member needs to be handled properly if you hope to minimize tax. Let me explain.
The opportunity

If I had my choice, I'd like to live forever. And so far, so good. Now, I expect that the value of our home will increase significantly between now and the day when Carolyn and I aren't here any more.

Suppose, for example, that I outlive Carolyn, and at the time of my death, our home is worth $500,000. Suppose also that we paid $300,000 for the home. At the time of my death, there will be a $200,000 capital gain triggered.

That gain will be sheltered from tax using my principal residence exemption.

You see, each family unit is entitled to designate one property as its principal residence each year, and the exemption is also available upon death.

Aside from the principal residence exemption, there may be another opportunity to save tax if your executor sells your home after you're gone.

Back to my example. Once I'm gone, my kids will likely sell our home in order to divide up the assets of the estate.

If that sale takes place shortly after my death, it's quite possible that a capital loss may be realized by my estate.

Here's what I mean: My estate will own my home after my death, and the adjusted cost base of the home to my estate will be $500,000 -- the fair market value at the time of my death.

If my executor sells that home for net proceeds less than $500,000, my estate will realize a capital loss. There's a pretty good chance of that happening after I'm gone. Why? Well, even if my executor sells the property for $500,000, the selling costs alone would create a capital loss.

Here's where the opportunity lies: If a capital loss is triggered by my estate in the first taxation year of that estate, the loss can be carried back to my final tax return to offset any capital gains that might have been taxable on that return. Subsection 164(6) of Canadian tax law allows this loss to be carried back. That's right, your heirs will be able to recover some tax that might have been paid on your final tax return if there is a loss in your estate when selling your home.
The problem

Is there a potential problem? Sure. A principal residence is normally considered to be "personal use property." And the tax collector won't allow you, or your estate, to claim a capital loss on personal use property.

As a result, you might have to kiss that 164(6) loss-carryback goodbye. But there's a way around this problem. You see, your residence, which will be owned by your estate after your death, will not be considered personal use property unless one of the beneficiaries of your estate (or someone related to a beneficiary) actually lives in the home after your death.

The bottom line? If your heirs expect to sell your home after your death and hope to claim a capital loss in the process to recover tax you paid at the time of your death, be sure that no beneficiary (or someone related to a beneficiary) ordinarily inhabits the place after you're gone.

My children will have a tough time knowing what to do with my orphan sock collection when I'm gone. But as for the house, I'll make sure they know exactly what to do.
Tim Cestnick, CA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, Tax Smart Services, at AIC Ltd.

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