Most people have heard about capital gains but few people understand how it works. So what is a capital gain exactly? Simply put, a capital gain is a realization of profit from the sale of capital property which includes stocks, as well as real estate. Keep in mind that there can also be a capital loss in a scenario where the asset is now worth less than the original purchase price, or when there are losses in some assets that offset the gains in other assets but this is a topic for another post.
As an example, let’s say that Meg and Jack own a home. This home is their primary home. They paid $500,000 when they bought the home. Meg and Jack also own a cottage. They paid $200,000 for the cottage several years ago. If Meg or Jack died today, there would be no capital gains as all property and assets could be rolled over to the surviving spouse. If the surviving spouse sells the cottage, then there would be capital gains assessed. There are no capital gains assessed on a primary residence.
However let us assume that Meg and Jack have children. Lyndsey and Lennox. There would then be capital gains assessed on the properties when the last spouse passes away, assuming the properties are worth more now than when originally purchased. So if Meg is the last spouse to pass away, the Canada Revenue Agency would deem all the property sold at current market value. The children, Lyndsey and Lennox would only receive the properties left to them by their parents after the estate has paid the capital gains on the property. So how is this assessed?
If for example the primary home is now worth $1,000,000 and the cottage is now worth $400,000, the combined gain for Meg and Jacks estate would be $1,400,000 – $700,000 (Original combined purchase price) = $700,000 (The gain on the properties). Lyndsey and Lennox would then be taxed on 50% of that gain at the marginal tax rate of Meg. If Meg’s marginal tax rate is 40% then Lyndsey and Lennox would be liable for $350,000 x .40 = $140,000 in taxes. This tax liability must be disposed of prior the estate giving the properties to the children. If Lyndsey and Lennox don’t have the money to pay those taxes, then the estate will have to liquidate all of Megs’ assets, pay the capital gains, probate and any additional fees, and only after will Lyndsey and Lennox receive any of their inheritance. After all is said and done, Lyndsey and Lennox may receive very little in terms of an inheritance.
How does life insurance help? Well, If Meg and Jack had purchased a participating permanent life insurance policy for $180,000 with dividends paid into the benefit amount of the policy every year, as soon as Meg passes away, the policy would pay out in full and untaxed to Lyndsey and/or Lennox earmarked to cover all tax liability as well as funeral costs. Lyndsey and Lennox would then receive the primary home and cottage to do as they wish. They may choose to keep the properties in the family, or sell for the FULL value of the properties.
To discuss how life insurance can be used to design a tax efficient estate plan, reach out to me directly and I will guide you through the process of choosing a policy that matches your needs.