Generally speaking, a personal trust is deemed to have disposed of its entire capital property and land inventory on the 21^st anniversary of the creation of the trust and every 21 years thereafter for proceeds equal to its fair market value and to have required the same property immediately thereafter for an amount equal to that fair market value.  This means trusts may be required to realize and pay tax on capital gains without actually receiving the proceeds of disposition.

The purpose of the 21-year deemed disposition rule is to prevent a trust from holding property for an indefinite period, thereby deferring the taxation of capital gains from generation to generation.

There are planning strategies to avoid the application of the rule; for example, ensuring the terms of the trust provide that the property can be distributed out to a Canadian resident beneficiary on a tax-deferred basis before the 21^st anniversary, such that the trust would hold no property with accrued gains.  This would defer the capital gains tax until the beneficiary disposes of the property, either by an actual or deemed disposition.

Here’s how it works:

Assume that a trust owns property that had an original cost base of $100, but its fair market value on the 21^st anniversary of the trust is $1,000.  On the 21^st anniversary the trust will be deemed to have disposed of the property for $1,000 and realize a $900 capital gain ($1,000 – $100).

But, if the terms of the trust permit, the property can be transferred to a Canadian resident beneficiary prior to the 21^st anniversary at its original cost base ($100), thereby deferring the accrued gain on the property until the beneficiary sells the property or dies.  The trust disposition would reflect the $100 of proceeds and not the $900 gain, thereby resulting in no capital gain for the trust.

It is extremely important for tax and trust advisors to be aware of when the 21^st anniversary of a trust is and to advise the trustees of the trust in advance of the deemed disposition in order to be able to engage in proper planning.