Spousal Trusts in Ontario: Tax Treatment and Rollover Rules

If you have a spouse and children from a prior relationship, you may want your spouse looked after during their life while keeping control over what is left afterward. A spousal trust set up in a will is a common tool for this.

This article explains how a spousal trust defers tax, the conditions it must meet, and when tax comes due on the survivor's death. Tax and estate rules are technical, so use this as background for a conversation with a lawyer or accountant.

Why tax matters at death

At death, a person is deemed to have disposed of 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.

There is an important exception, called the spousal rollover. If capital property passes to a surviving spouse or common-law partner 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 zero, and the survivor takes over the deceased's cost.

Conditions for a qualifying spousal trust

A qualifying spousal trust 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.

The property must also be locked in, meaning it vests indefeasibly in 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.

• The trust is created by the will.
• The spouse is entitled to all income before their death.
• No one else can receive or use income or capital during the spouse's lifetime.
• The property vests in the spouse or trust within the time allowed.

What happens if the trust does not qualify

A spousal trust that does not meet the conditions is sometimes called a tainted trust, and it does not get the rollover. A cure under s. 70(7) is available only where the problem is testamentary debts.

This is why drafting matters. A clause that lets a child or anyone else receive income or capital while the spouse is alive can cost the estate the deferral.

The rollover is also not forced on you. The legal representative can elect in the final return, property by property, to transfer at fair market value instead of using the rollover. Whether that makes sense depends on the facts, so ask an accountant.

Tax on the survivor's death

The tax is deferred, not erased. Under s. 104(4), a spousal trust is deemed to dispose of its capital property at the end of the day the beneficiary spouse dies, and this is when the deferred gain is taxed.

For a blended family, this ties tax planning to the protection goal. How the trust's tax bill is paid and who bears it is a point to settle with your advisers when the will is drafted.

What to do next

• List the capital property you own and its approximate cost compared with its current value.
• Decide who you want to provide for during your spouse's life and who should benefit afterward.
• Ask a lawyer to draft the will so the trust meets the conditions.
• Ask an accountant about the election to opt out of the rollover on particular assets.
• Review your will if your family or property changes.

Frequently asked questions