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January 9, 2017

21 Year Rule for Trusts & Deemed Realization

In Canada, trusts can be an effective vehicle to not only facilitate income splitting with family members but also to help taxpayers meet their estate planning objectives. It is important to review the corporate structure on a regular basis to ensure the trust is still serving a purpose, and to plan well in advance for the deemed realization rules. Commonly referred to as the “21 year rule,” the rule deems certain types of trusts to dispose of their capital property and recognize the accrued gains every 21 years. Without this rule, trusts could be used to defer the realization of a capital gain for more than 21 years (80 years in BC).

The 21 year deemed disposition date applies to most trusts (i.e. family trusts and testamentary trusts created for beneficiaries other than spouses or common law partners). However, for other types of trusts the first deemed disposition does not occur 21 years after creation of the trust. For example:

  • An alter ego or self benefit trust will be first deemed to dispose of its capital property on the death of the taxpayer. 

  • A spousal trust or a joint partner trust will be first deemed to have disposed of its capital property on the death of second spouse to die.

These dates mirror the deemed disposition dates that would otherwise occur on the death of the taxpayer (or the later of the taxpayer or their spouse in the case of a spousal trust). For life interest trusts planning cannot be utilized to defer the gain beyond the death of the settlor (or the spouse).

Planning for the Deemed Realization

For trusts to which the first deemed realization will occur on the 21st anniversary of the settlement date there are options available to defer the tax that would otherwise be triggered.

Some common tax deferral techniques are discussed below.

1. Capital Distribution of Property to the Beneficiaries

If the trust deed allows for a capital distribution to the beneficiaries and the beneficiaries are resident in Canada, it may be possible to roll the capital property to the beneficiaries without triggering tax. The beneficiaries can then continue to hold the property, without triggering a taxable gain, until the earlier of the sale of the property or their death.

This option is often chosen when the property held by the trust has significant inherent capital gains that will otherwise be triggered on the deemed realization date. In addition, it is often the preferred option when the trust has no liquid assets available to pay the tax or if there is reluctance to ‘prepay’ the tax.

2. Share Reorganization with a Capital Distribution

Where a trust owns shares of an operating company, it may be beneficial to ‘freeze’ the current common shares held by the estate, issuing preferred shares in exchange. The freeze shares can then be distributed to the beneficiaries and the trust can subscribe for the new growth shares of the company. The new shares will be subject to the deemed realization rules, however, as their value will be nominal, little or no tax will be triggered.

This planning should only be undertaken if there is comfort that the beneficiaries, who will hold the preferred shares, will not seek to redeem their preferred shares.

3. Vest Indefeasibly

An exception to the deemed realization rules is provided where all interests of the trust have vested indefeasibly. The interests of the beneficiaries are considered to have “vested indefeasibly” when the interest of each beneficiary is fixed and the trustee has no discretion to alter the interests. Planning could be implemented to “vest” the property to the beneficiaries and therefore defer the tax until the earlier of the sale of the property or the death of the beneficiary. However, the implications of the vesting, including the potential for the beneficiaries to cause the trust to be wound-up and the exposure of the vested interest to creditors of the beneficiaries, needs to be considered.

4. Pay the Tax

There is a common misconception that the 21 year rule income tax act requires that a trust be wound up within 21 years. This is not true. The rule simply deems a trust to have disposed of each property of the trust for proceeds equal to the fair market value (“FMV”) of the property on the deemed realization date, and to reacquire the property immediately thereafter. There are a number of situations where it may make sense to have the trust recognize the accrued gains on the property and pay the tax.

For example:

  1. Where the trust holds an investment portfolio that is frequently traded, the accrued gain may be nominal and therefore, triggering the gain will not result in significant tax.

  2. If the trust holds private company shares, the share rights and restrictions should be reviewed to determine the value of the shares held by the trust. If the trust shares are entitled to dividends, but have no right to share in the growth of the company, the accrued gain may be nominal.

  3. Where the trust holds qualified small business corporation (“QSBC”) shares, it may be possible to shelter all (or some) of the tax triggered by utilizing the capital gains exemption of the beneficiaries.

  4. If the intention is to sell the property in the near future the tax will be triggered when the property is sold. By triggering the gain (and the tax payable) on the deemed disposition date the proceeds can remain in the trust and not in the hands of the beneficiaries.

  5. Often assets are held in trust because the beneficiaries are too young, have mental health issues, addiction problems, or are not financially responsible. Under these circumstances it may make sense for the trust to pay the tax and continue to hold the property in trust.

If the tax is to be paid by the trust, planning will be required to ensure there is sufficient liquidity in the trust. If the underlying assets are not being sold, sufficient cash may not be available. There is an election available to pay the tax in ten equal, annual installments. However, security must be provided and interest will be payable on the deferred tax.


Planning for the deemed realization rules is complex and the options suggested above may not be appropriate for all trusts. Prior to making any decision it is advisable that the trustee seeks professional advice. The trust deed must be reviewed to determine if there are any restrictions on the course of action to be taken.

Please contact the Manning Elliott Tax Team if you have any questions or need assistance on this matter.

The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.