Spousal Trust Tax Rules in Ontario: Rollover and Taxation

When someone dies, the tax system treats their property as if it had been sold. A spousal trust is one of the ways the tax on that deemed sale can be pushed into the future. If you are a surviving spouse or a trustee, you need to know what is deferred, what is not, and when the bill arrives.

This article walks through the tax rules in order: the default rule at death, the rollover into the trust, the deadlines, and the tax at the survivor's death. The details of your own estate can change the result, so an accountant should review them.

The default rule at death

At death, a person is deemed to have disposed of their capital property at fair market value immediately before death. That can create a large capital gain on the final return, even though nothing was actually sold.

Registered plans are handled separately. For an unmatured RRSP, the deceased is considered to have received the RRSP's fair market value at death, reported on the final return. If the spouse or common-law partner is the sole beneficiary and all RRSP property is transferred to a plan for the spouse by December 31 of the year after death, the deceased is not taxed on the RRSP value.

How the rollover into a spousal trust works

There is an exception. If capital property passes to a surviving spouse or common-law partner who is resident in Canada, or to a testamentary spousal trust, the deceased is deemed to sell at adjusted cost base. The capital gain on the final return is then zero. The survivor takes over the deceased's cost.

To get this treatment, the trust has to qualify. It must be created by the deceased's will, the surviving spouse must be entitled to all trust income arising before their death, and no one else may receive or use trust income or capital during the spouse's lifetime.

Deadlines and ways the rollover can be lost

• The property must be locked in for the spouse or trust no later than 36 months after death.
• A written extension request can be made to the Tax Services Office before the 36 months end.
• A trust that does not meet the conditions is a tainted trust and does not get the rollover.
• A cure under section 70(7) is available only where the problem is testamentary debts.

Because the trust has to come from the will, mistakes in the wording are hard to fix afterward. If you are a trustee and something looks off, speak to a lawyer early.

Choosing not to use the rollover

The rollover is not always forced. The legal representative can elect in the final return, property by property, to transfer at fair market value instead of using the rollover. People sometimes consider this where the deceased has losses to use up. Whether it makes sense depends on the whole return, which is a question for an accountant.

RRIFs have their own rule. If the RRIF contract or will names the spouse or common-law partner as successor annuitant, the deceased is not taxed on the RRIF value, and the survivor reports the payments. Without a successor annuitant, the RRIF's fair market value is included in the deceased's income.

Who is taxed, and when

The rollover defers the tax on capital gains; it does not cancel it. The deferred gain is taxed when the trust is deemed to dispose of its capital property at the end of the day the beneficiary spouse dies. That is the point where the earlier growth is taxed.

How the trust's yearly income is taxed, and who reports it, depends on the terms of the trust and what the trustee does each year. Since the survivor must be entitled to all the trust income arising before their death, the income is a key piece of the reporting. A trustee should get accounting advice on the yearly filings.

A surviving spouse or common-law partner can defer tax on a refund of premiums by transferring it to their own RRSP, PRPP, SPP, RRIF or eligible annuity. The transfer must be completed in the year received or within 60 days after the end of that year. To transfer into an RRSP, the survivor must be 71 or younger at the end of the year of transfer, and older survivors can use a RRIF or annuity instead. How these registered plan rules fit with a spousal trust depends on your situation, so it is worth confirming with an accountant.

What to do next

• Get a copy of the will and confirm it creates the trust.
• Note the date of death and count 36 months forward for the locking-in deadline.
• List the capital property and its original cost.
• Ask the accountant whether to use the rollover or elect out, property by property.
• Keep clear records of trust income and distributions.

Frequently asked questions