Bitcoin, Ethereum, Polygon, Avalanche, and Fantom are just some of the cryptocurrencies used for investment by many Canadians. There are also non-fungible tokens, or NFTs, which are becoming ever more mainstream in the world of collectibles and art.
Considering the growing popularity of both, it's fair to say a lot of investors need to know the tax implications for having and selling NFTs or cryptocurrency.
Capital Property Taxation upon Death
There is no 'death tax' in Canada for inheritance. However, the Income Tax Act triggers a deemed disposition, including all the capital property of the deceased taxpayer at market value.
There are also exemption provisions if the property goes to the deceased's spouse, spousal trust or common-law spouse. In that case, tax will be deferred on any accrued gains until the deceased's spouse or equivalent is deemed to have disposed of the property.
There is still no deemed disposition provision for any inventory properties which generate business income, meaning such assets can pass to the estate tax-free, and tax would only be incurred when the assets are disposed of.
Cryptocurrencies and NFTs are not always viewed as capital property under Canadian law. They might be considered inventory if handled in a manner that's consistent with generating business income.
Whether or not a business income was generated from the cryptocurrencies when the deceased was alive determines whether that income is viewed as business income or capital gains as per the Income Tax Act.
Tax Deferral for Crypto and NFTs
If the portfolio is classified as capital property generating capital gains, estate planning structures must be correctly set up to defer the deemed disposition under subsection 70(5). If it's not deferred, estate beneficiaries will pay more in tax. Let's look at a couple of examples:
- Michael died with $500,000 worth of cryptocurrency, having an adjusted cost base of $200,000. After the deemed disposition, the capital gain was $300,000. The estate trustee didn't dispose of this portfolio for 18 months after the death for $600,000, meaning a capital gain of $100,000. The estate paid tax on the original $300,000 capital gain and the $100,000 capital gain for estate disposition.
- Celia (unrelated to Michael) also died with $500,000 of cryptocurrency, but her adjusted cost base was $200,000. After the deemed disposition, the deemed capital gain was $300,000. But in this case, when Celia’s estate trustee disposed of the portfolio after 18 months, it was only disposed of for $400,000 since the crypto market had dipped. The estate paid tax on the $300,000 in capital gain but could not carry the $100,000 capital loss forward or back because the estate was legally deemed to have received the assets when Celia died.
To prevent what happened with Celia’s estate, taxpayers should think about using estate planning structures to defer the deemed disposition tax.
Section 85 Rollover and Transferring of Assets
With this method, a transferor may sell taxable property to a transferring corporation for a specified amount which becomes the disposition proceeds and the foundation for determining the transferee's tax costs on the property.
The transferor may defer some or all the tax liability they would otherwise face on a transfer to a corporation by enabling the taxpayer to transfer property for cost instead of for 'fair market value.' Then the corporation as a taxpayer becomes the legal owner of the property under the Income Tax Act. However, shares in the holding company are still subject to the deemed disposition law, so it's a good idea to seek estate planning advice from one of our accountants at Tax Partners.
Gift to Spouse – Tax Implications
The deceased may pass assets to their spouse or spousal trust to defer tax. When the spouse passes away, the tax deferral advantage ends, and the property is deemed for disposal. The tax deferral benefits via gifting to a spouse may be limited depending on various circumstances and the anticipated lifespan of the couple.
Inter Vivo Trust – Tax Implications
This type of trust holds the settlor's assets. The settlor transfers their capital property to the inter vivo trust, which is then the property's legal owner, so the property isn't subject to the deemed disposition law. In this case, however, the settlor must pay applicable capital gain taxes according to the property's fair market value.
An inter vivo trust means a flexible structure in listing beneficiaries, perhaps the children of the deceased and future grandchildren. A third-party trustee runs the trust, using their discretion to allocate income to beneficiaries. Unlike shareholders in a company, beneficiaries can't vote to influence trust operations. A trust can be a corporation shareholder, and a corporation can also be a trust beneficiary.
As with any tax-related matter, it is essential to do your due diligence. Tax Partners can write a well-examined memo to prove due diligence against any future CRA reassessments.
More information about Tax Partners, please visit our YouTube channel or contact us at 905-836-8755. Alternatively, you may email us at info@taxpartners.ca.
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