Tax changes and estate planning

Question: I understand the mini-budget brought down by Paul Martin before the election has an impact on estate planning. Can you explain?

Answer: The main effect is to reduce the tax impact of capital gains that are realized at death. Under the law, when you die any assets you own are deemed to have been sold for tax purposes. This means that all capital gains on stocks, mutual funds, real estate, etc. become taxable in the year of death, unless the estate is passing to your spouse.

In the October mini-budget, Mr. Martin reduced the capital gains inclusion rate to 50%. That was the second time in 2000 the rate had been dropped; the first was in February when it was cut from 75% to 66.67%.

The effect is to reduce the amount of tax payable on realized capital gains. This can be especially significant in situations such as that of a family cottage being passed from one generation to the next.

For example, suppose a cottage was purchased back in the 1960s for $100,000. It’s appraised value on the death of the last surviving spouse is $500,000 quite possible in some parts of the country. That produces a capital gain of $400,000.

Prioto 2000, 75% of that gain, or $300,000, had to be declared as taxable income. Assuming the estate was assessed at a marginal rate of 50%, that created a tax liability of $150,000. As a result of the lower inclusion rate, however, the taxable portion of the gain is reduced to $200,000 and the tax payable would be cut by a third, to $100,000. That’s still a substantial amount, but it’s a lot less than in the past. The difference could be enough to ensure the cottage stays in the family rather than being sold to pay taxes.