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

Many families set up a trust, or inherit one through a will, without thinking about what happens decades later. Tax law does not let a trust hold growing property forever without a tax checkpoint. That checkpoint is often called the 21-year rule.

If you are a trustee or a beneficiary, it helps to know what the rule does, which trusts it applies to, and what the trustee has to do as the date nears. This article explains the basics in plain language. Your trust's own wording and numbers matter a great deal, so a lawyer or accountant should review the details.

What the 21-year rule means

Generally, a trust is deemed to dispose of its capital property at fair market value every 21 years. The word deemed matters. The trust does not actually have to sell anything. The tax rules simply treat it as if it had sold the property at its then-current value.

If the property has gone up in value since the trust bought or received it, that increase is the gain that gets reported. The rule is found in section 104(4)(b) of the Income Tax Act. Capital property is generally property held for the long term, such as shares or real estate, rather than inventory.

Tax law divides trusts into two broad groups. A testamentary trust is generally created on and because of a person's death. An inter vivos (living) trust is any trust that is not a testamentary trust. The 21-year rule is a trust rule, so it is not limited to one group.

How the gain is taxed

The deemed gain is taxed inside the trust. A trust's taxable income is generally taxed at the highest individual percentage, the top personal rate, under section 122(1) of the Income Tax Act. That can make a large deemed gain expensive, so the date is worth planning for well ahead.

There are exceptions to the flat top rate. Graduated rate estates and qualified disability trusts are not taxed that way under section 122(1). Because they are different from ordinary trusts, they are explained next.

Trusts that are treated differently

• Graduated rate estate (GRE): this is the estate that arises on a person's death, and it can only be a GRE for up to 36 months after the death. There can be only one GRE for a deceased person, and it must designate itself as one on its first T3 return. It has a deemed tax year-end on the day it stops being a GRE.
• Qualified disability trust (QDT): a testamentary trust that arose on a death can be taxed at graduated rates as a QDT. It must jointly elect with one or more beneficiaries on Form T3QDT and meet other conditions.
• Spousal, alter ego and joint partner trusts: the first deemed disposition happens on the day the beneficiary spouse dies, or on the later of the two deaths, rather than on the usual 21-year date.

An alter ego trust is a living trust created after 1999 by a settlor who was 65 or older, and the settlor must be entitled to all of the trust's income during their lifetime. A joint spousal or common-law partner trust is also created after 1999 by a settlor aged 65 or older, and the settlor and their spouse or partner must be entitled to all of the income until the later of their deaths.

For a testamentary spousal trust, the tax rollover under section 70(6) requires that the surviving spouse or partner be entitled to all of the trust's income for life, with no one else receiving or using income or capital during their lifetime. The property must also vest indefeasibly in the spouse or the trust within 36 months after the death, although the Minister may allow a longer period if a written application is made within that time. Whether your trust qualifies depends on its exact terms.

T3 filing, deadlines and penalties

A trust must file a T3 return if it is a Canadian-resident express trust that is not a listed trust. Other trusts must file only if they meet conditions such as having tax payable or being asked to file. Certain listed trusts are generally exempt from filing under section 150(1.2) of the Income Tax Act. The listed categories have been changing, so ask an accountant to confirm the current rules before relying on an exemption.

A trust that must file a T3 return generally must also report beneficial ownership information on Schedule 15. A T3 return is due no later than 90 days after the trust's tax year-end.

Trustee duties as the date approaches

In investing trust property, a trustee must use the care, skill, diligence and judgment of a prudent investor under section 27(1) of the Ontario Trustee Act. A trustee must consider listed criteria when planning investments, must diversify to an appropriate extent, and may obtain investment advice. A trustee may also delegate investment functions to an agent.

These powers do not authorize or require a trustee to act inconsistently with the terms of the trust. A trustee is not liable for an investment loss if the conduct that led to it followed an investment plan or strategy that a prudent investor could adopt.

If the right course is unclear, a trustee may apply to the Superior Court of Justice, without starting an action, for the court's opinion, advice or direction on managing trust property. A trustee who pays a trust expense personally, such as professional tax advice, may recover it from the trust property, although the court may later disallow it.

What to do next

• Confirm the date the trust was created and what type of trust it is.
• Find out whether the trust is spousal, alter ego or joint partner, since the timing differs.
• Collect records of what the trust owns and what each asset cost.
• Ask an accountant to estimate the tax well before the anniversary.
• Diarize the T3 deadline and any Schedule 15 reporting.
• Keep written records of investment decisions and any advice obtained.
• Speak with a lawyer if the trust terms are unclear or the beneficiaries disagree.

Frequently asked questions