Executors: Prepare for CRA’s due diligence on deceased’s real estate

Occasionally, an estate executor may be in a situation where a deceased’s estate includes a real estate property that consists of attached principal residence and commercial space, which sparks a number of tax-related issues.

First, there would be a deemed disposition declared on the deceased’s final personal tax return. This deemed disposition would be in respect of the commercial property space since the principal residence space would fall under the principal residence tax exemption (unless part of the principal residence was rented to a third party, discussion of which is beyond the scope of this article). Therefore, the first challenge for the deemed disposition purpose would be to determine the space allocation between the principal residence and the commercial enterprise.

The next task for the purpose of the deemed disposition would be to determine the market value of the property. This in itself can be a difficult endeavour since the nature of the property is both residential and commercial. In particular, one needs to consider the nature of the business occupying the commercial space as well as what portion of the commercial space is land and what is building.

Only when these issues are vetted can a proper valuation be attached to the commercial space when declaring the deemed disposition on the deceased’s final tax return.

This brings us to the executor’s ultimate tax-related objective and that is to obtain the Clearance Certificate from the Canadian Revenue Agency (CRA) for the deceased’s tax liability up to the date of death (this discussion does not relate to, or consider, the need for a further Clearance Certificate for the period from the date of death up to the wind-up date of the deceased’s estate.)

When CRA receives the request made by the executor for a Clearance Certificate, it is almost a certainty that they will perform their own due diligence with respect to the value of the real estate (and would include work on both the residential and commercial space.) Most likely the matter will be referred to CRA’s Real Estate Appraisal Section.

That section will request further information such as:

1) Documents showing a property valuation by a realtor or certified valuator;

2) Supporting market data utilized in the preparation of that valuation;

3) If there are any environmental issues relating to the property, the CRA will enquire whether there were any environmental investigations conducted and if so, to provide them with the reported findings;

4) Enquiry on whether any part of the commercial space was leased or rented to any third parties or did the deceased operate a business in the commercial space and reside in the residential space; and

5) If any part of residential and/or commercial spaces were leased to a third party, to provide to them copies of the lease(s) in effect at the deemed disposition date.

Only after conducting a thorough investigation to substantiate the value of the property will the CRA issue a Clearance Certificate.

It follows, then, that when valuing real estate for the purpose of a deemed disposition in a deceased’s final personal tax return, particularly in cases where the property consists of attached principal residence and commercial space, executors are advised to take the valuation process very seriously as they will likely be called upon to provide strong evidence to support their valuation.