Everyone knows that you can’t avoid the tax collector, and death is no exception. Under the Canadian Income Tax Act, on the death of an individual subsection 70(5) will trigger a deemed disposition of all the deceased taxpayer’s capital property at fair market value thus taxing any accrued capital gains in the deceased’s final tax return. There is an exception to this deemed disposition rule which will defer the taxation of accrued gains on any capital property that is left to the deceased’s spouse, common-law partner or a spousal trust.
What does death and taxes have to do with Bitcoin or other forms of cryptocurrency?
Bitcoin, Litecoin, Ethereum, Polkadot, and the many other cryptocurrency coins and tokens are considered capital property. Unless these coins or tokens are bequeathed to a surviving spouse, they will be deemed disposed of upon the death of the crypto holder just like any other capital property that was not bequeathed to the surviving spouse. The deemed disposition will be a taxable event that could result in a capital gain reported on the deceased’s final tax return.
Cryptocurrency can provide various challenges to an executor or executrix of the deceased’s estate. Steven Frye, Baker Tilly WM LLP, wrote a good article called “A Note on Crypto Currency” about one of the challenges faced when the deceased crypto holder was too secretive leaving the executor with the inability to access the digital assets. Another challenge faced by the executor is the fluctuation in the market value of many cryptocurrencies. This is best explained through an example:
Example of a fluctuation in the market value of Bitcoin
Mr. Anonymous, an Ontario resident, passed away on December 15, 2017 holding 100 Bitcoins valued at $2,527,100 (FMV per Bitcoin = $25,271). Mr. Anonymous, who just recently discovered the world of cryptocurrency, purchased his 100 Bitcoins on January 20, 2017 for $123,200 (ACB per Bitcoin = $1,232) holding them until his untimely death less than a year later. Mr. Anonymous who was not married and had no children bequeathed his entire estate, including his Bitcoin, to his sister. On Mr. Anonymous’ final tax return, his executor reported a $2,403,900 capital gain from the deemed disposition of the Bitcoin under subsection 70(5) generating approximately $643,524 in tax payable on the capital gain.
Luckily, Mr. Anonymous was meticulous with his records leaving his digital key and access codes in a safe place available for his executor. His sister did not believe in Bitcoin, so she instructed the executor to liquidate all the Bitcoin, pay the respective estate tax and leave her with the remaining funds. The executor did not liquidate the Bitcoin right away, and it was not until July 27, 2018 that the executor finally got around to converting the Bitcoin into Canadian dollars. At the time of the actual sale, Bitcoin was trading at a lower value per coin of $10,757 which resulted in proceeds of $1,075,700, creating a loss of $1,328,200 from the value reported on the final tax return. After the executor paid the estate taxes, the sister received $432,176 in Canadian dollars.
Loss carry-back strategy ITA subsection 164(6)
In this situation, Mr. Anonymous’ final tax return reported a $2,403,900 capital gain on the deemed disposition of the Bitcoin. His estate, which is a separate entity for tax purposes, reported a $1,075,700 capital loss on the actual disposition of the Bitcoin. If the estate does not have other capital gains to utilize this capital loss, then the capital loss on the sale of the Bitcoin will be lost forever. Now the executor was smart enough to seek the advice of a tax expert who recommended applying the loss carry-back strategy under subsection 164(6) of the Income Tax Act which will enable the executor to carry this capital loss back and amend the deceased’s final tax return offsetting a portion of the capital gain from the deemed disposition of the Bitcoin. To apply this strategy, the estate must be a designated graduated rate estate and the loss on the sale of the Bitcoin must have occurred within the first taxation year of the estate.
As a result of implementing this loss carry-back strategy, the amended final tax return of Mr. Anonymous reported a net capital gain of $1,328,200 ($2,403,900 capital gain – $1,075,700 capital loss) resulting in a revised tax bill of $355,559 saving approximately $287,965 in taxes. Now the executor may still be accountable for the delay in the sale of the Bitcoin that resulted in significantly less cash to the estate, but at least the advice from the tax expert allowed for recovery of some of the tax.
Monitoring market value
When cryptocurrency is part of a deceased’s estate, it is very important for the executor to monitor the market value for fluctuations between time of deemed disposition and actual disposition, and if the value starts to decline and the estate incurs a loss, then utilizing the loss carry-back strategy under subsection 164(6) of the Income Tax Act can help to reduce the overall tax burden of the estate.
 For ease of reading, future reference to “spouse” will represent “spouse, common-law partner or spousal trust”
 For ease of reading, further reference to “executor” will represent “executor and executrix”
 Capital gain equal to Bitcoin’s FMV on day of death less its ACB ($2,527,100 – $123,200)
 Highest marginal tax rate on capital gains in Ontario for 2017 was 26.77%