The 21-Year Rule for Family Trusts in Ontario: What Happens at Year 21?

If you are the trustee of a family trust that is approaching its 21st anniversary, you may have heard of a tax rule that can create a large bill even though nothing was sold. It is often called the 21-year rule.

This article explains the general idea, what it means for tax on a trust and the kinds of options trustees usually discuss with their advisers. The details turn on your trust's assets and wording, so use this as a starting point for that conversation.

What the 21-year rule says

Under the Income Tax Act, a trust is deemed to dispose of its non-exempt capital property at fair market value on the day 21 years after the latest of January 1, 1972 and the trust's creation. It is then treated as reacquiring the property at that value, and the same thing happens again every 21 years.

In plain words, the trust is treated as if it sold the property and bought it back, even though no sale took place. If the property has gone up in value, the increase can be taxed, and the trust may have to pay without having received any cash from a sale.

Which trusts and which property

An inter vivos trust is any trust that is not a testamentary trust. A testamentary trust is generally created on and as a result of an individual's death, for example under a will or estate. The 21-year rule is a trust-wide rule, so it is worth confirming whether your trust is caught.

• The rule applies to non-exempt capital property, so the type of asset matters.
• Alter ego trusts and joint partner trusts use the death of the settlor or last beneficiary instead of the 21-year date.
• Pension-type PRPP trusts are excluded from the 21-year rules.
• An alter ego trust is set up by a settlor aged 65 or older who is the only person entitled to income or capital during their lifetime. A joint spousal or common-law partner trust is created by a settlor aged 65 or older, with the settlor and spouse or partner receiving all income until the later of their deaths.

Why the tax can be heavy, and why you cannot just move assets

An ordinary trust that keeps its income is generally taxed at the top individual rate, without graduated brackets. A trust can deduct income that becomes payable to a beneficiary in the year, and the beneficiary then includes that amount in their own income. That is why trusts often pay out income, but a deemed gain from the 21-year rule is a separate question that you should model with your accountant.

Moving property from one trust to another does not postpone the 21-year date. The receiving trust's date is set to the earliest of specified dates tied to the transferor trust, with exceptions for spousal, alter ego and joint spousal trusts. Simply transferring assets to a new trust is therefore not a safe way to reset the clock.

Options trustees commonly discuss

There is no single right answer, and the tax result of each option depends on the assets, their cost and current value, and who the beneficiaries are. These are the usual topics for a conversation with your accountant and lawyer, well before the anniversary.

Ending a trust early is only possible when the strict conditions are met, and a sole competent adult who is absolutely entitled can collapse the trust. If any beneficiary is a minor, unborn or unascertained, the Office of the Children's Lawyer may need to be involved in certain court applications.

Reporting and what to do next

A T3 return and any balance owing are due no later than 90 days after the trust's tax year-end. A resident express trust that is not a listed trust must file a T3 every year, even with no income. Most trusts that file a T3 must include Schedule 15 with beneficial ownership information. A late T3 with no unpaid tax at the deadline carries a penalty of $25 a day, minimum $100, maximum $2,500.

• Find the date the trust was created and calculate the 21st anniversary.
• List every asset with its cost and current fair market value.
• Read the trust document for who can receive property and when.
• Ask an accountant to estimate the tax and how it would be paid.
• Ask a lawyer whether distributing property or ending the trust is possible.
• Diarize the T3 and T1055 reporting deadlines.

Frequently asked questions