Cross-Border Inheritance: How Canada and the U.S. Tax Estates and Inheritances

As families live and invest across borders, many people are surprised to learn how differently Canada and the United States handle taxes when someone passes away.

For Canadians inheriting from U.S. relatives, or for U.S. citizens living in Canada, the tax rules can be complex.

In this article, we’ll look at a practical example to show how both countries tax an estate, what happens to investments and RRSPs, and how concepts like the “stepped-up cost basis” work to your advantage.

Let’s start with an example: John and Anna Smith

John Smith was a U.S. citizen who lived in Toronto for many years. He passed away on October 31, 2025, leaving everything to his daughter, Anna, who also lives in Canada.

At the time of his death, John owned three main assets:

• A Toronto home bought in 1985 for $200,000, now worth $1.5 million.
• An RRSP with a value of $1 million.
• 1,000 shares of Royal Bank Inc. purchased in 1993 for $8 each, now worth $92 each.

How does Canada tax an Estate?

Let’s start with where John lives. Canada does not have an inheritance tax.

Instead, when someone dies, the law treats all their property as if it were sold at fair market value right before death. This “deemed sale” creates capital gains and other income that must be reported on the deceased person’s final (terminal) income-tax return.

The estate, not the beneficiary, pays this tax.

John’s home rose in value by $1.3 million, but because it was his principal residence, the entire gain is tax-free under the principal residence exemption. Anna inherits the house with a cost base of $1.5 million. If she later sells it for $1.6 million, she’ll only pay tax on the $100,000 increase that happened after she inherited it.

John’s shares increased in value from $8,000 to $92,000, creating an $84,000 gain.
In Canada, only half of a capital gain is taxable, so $42,000 would be added to his income.
At a 50 percent marginal rate, this means roughly $21,000 of tax.

The largest tax bill comes from the RRSP, which we explain next.

What Happens to an RRSP When Someone Dies?

When a Canadian-resident RRSP holder dies, the plan is deemed to be collapsed immediately before death. This means the entire value of the RRSP is included as income on the person’s final tax return.
The investments inside the RRSP are not automatically sold for tax purposes, but the account is valued at its fair market value.

A tax-free rollover is possible only in limited cases, for example, when the RRSP goes to a spouse or a financially dependent child.

In John’s case, Anna is an adult, not a dependent child, so no rollover applies.
The full $1 million RRSP is taxable as income on John’s final return, resulting in roughly $500,000 of tax at a 50 percent rate.

After death, the financial institution freezes the RRSP until the estate paperwork is complete.
Once ready, it usually sells the investments, converts them to cash, and then pays the proceeds to the named beneficiary or to the estate.

Because Anna is the direct beneficiary, she receives the full $1 million from the RRSP, but the estate is responsible for paying the income tax.
This can cause cash-flow problems: the estate might need to sell other assets, like John’s house, to cover the CRA tax bill.

Financial institutions rarely withhold the full amount of tax owed.
If they pay the RRSP to the estate, they usually withhold nothing; if they pay it to a beneficiary, they might withhold 25 percent, far less than the true liability.
The executor must report the entire amount on John’s final return and pay the balance owing.

If the beneficiary is a spouse, the RRSP investments can often be transferred “in kind” to the spouse’s RRSP or RRIF without selling them.
For adult children like Anna, the investments must be sold and paid out in cash.

What happens to RRSPs for U.S. Citizens?

Because John was a U.S. citizen, the IRS views his RRSP as a foreign pension plan.
Under the Canada–U.S. Tax Treaty, the U.S. does not tax the RRSP when the owner dies.
The income inside the plan remains tax-deferred until it is withdrawn.

So while Canada taxes the full $1 million RRSP as income at death, the U.S. does not recognize any income yet. The plan’s value is simply included in John’s U.S. gross estate for estate-tax purposes. This difference creates a timing mismatch. Canada collects tax right away, but the U.S. waits until withdrawals occur, and it often prevents claiming a U.S. foreign-tax credit for the Canadian tax paid.

Understanding the “Stepped-Up Cost Basis”

When someone dies, both Canada and the U.S. generally reset the cost base of inherited assets to their fair market value at the date of death.

This is called the stepped-up cost basis.

It prevents double taxation because the deceased’s estate has already paid tax on any gains that occurred during their lifetime. The beneficiary only pays tax on increases in value that happen after they inherit the asset.

For example, Anna inherits her father’s home at a value of $1.5 million.
If she later sells it for $1.6 million, only the $100,000 difference is taxable. Without this step-up, she would have been taxed on the full $1.4 million gain, the increase from $200,000 to $1.6 million.

How the U.S. Taxes a Canadian Estate?

The U.S. tax system is quite different. Rather than taxing deemed sales, it imposes an estate tax on the total value of the deceased’s worldwide assets.
For 2025, each person can pass on up to USD $13.61 million tax-free.

John’s worldwide estate was worth roughly USD $1.9 million, well below the exemption, so no U.S. estate tax is payable. Even if his assets had exceeded that limit, the Canada–U.S. Tax Treaty would allow a foreign-tax credit in Canada to prevent double taxation.

The U.S. also does not tax unrealized gains at death. John’s home, shares, and RRSP are all included in his estate valuation but not taxed until they’re sold or distributed.

The Combined Outcome

After everything is settled:

• John’s estate pays about $521,000 in Canadian income tax, mostly from the RRSP inclusion.
• No U.S. estate or income tax applies because the estate is below the exemption.
• Anna receives the house, RRSP proceeds, and shares after the Canadian tax has been paid by the estate.
• Any future gains she earns are taxed only from the date she inherits them.

Where to start if you have family across borders?

When your family spans the Canada-U.S. border, estate planning gets complicated. Canada and the U.S. have completely different tax systems, which means even well-thought-out plans can hit snags.

The timing problem. Canada wants its tax money immediately when someone dies, while the U.S. often waits until assets get sold or distributed. This creates cash flow issues, especially with RRSPs. When a Canadian resident dies, their entire RRSP counts as income on their final tax return, but the U.S. might not recognize that for estate tax purposes until later. The estate could face a huge Canadian tax bill before claiming any U.S. relief. You can avoid this through gradual withdrawals, life insurance, or smart beneficiary choices.

Naming your spouse can defer or eliminate taxes, while naming adult kids directly accelerates them. Sometimes naming your estate as beneficiary simplifies paperwork and aligns who receives money with who pays the tax. These small decisions make a big difference. The principal residence exemption can shelter your home’s appreciation from tax, but only with proper documentation. Keep purchase agreements, renovation receipts, and proof of residence so your executor can confidently make the claim.

The estate tax exemption drops by roughly half after 2026. Most Canadians aren’t affected now, but if you own U.S. real estate or hold American securities, you could suddenly be over the threshold. Check valuations annually. Use identical fair market values when filing with both the CRA and IRS. Mismatched numbers slow settlements and can trigger audits.

The key is coordination, aligning Canadian estate law, U.S. reporting rules, and your family’s needs. Cross-border inheritance is not as simple as passing assets to loved ones.
Different systems, timing rules, and valuation methods can lead to mismatched taxes between Canada and the U.S.

In John and Anna’s case, Canada collected tax on the RRSP and capital gains, while the U.S. estate-tax exemption meant no additional U.S. liability. With careful planning, families can avoid double taxation and make sure that more of their wealth stays where it belongs with their heirs.

At Madan Chartered Accountant, we specialize in cross-border estate and inheritance planning. We help clients file final returns in both countries, claim foreign-tax credits properly, and design strategies to minimize tax exposure.