“we suggest that… you make note of and track the 21st anniversary dates of your trusts.”
Trusts have increasingly proven themselves to be an effective tax and estate planning tool over the past number of decades. These vehicles have been around long enough that the tax implications of the “21st Anniversary Date Rule” are now starting to create tax challenges (in some cases, for the second time). Subject to certain exceptions, the 21st Anniversary Date Rule deems a trust to have disposed of all of its capital property at fair market value (FMV) on each 21st anniversary date of the trust. Absent planning to mitigate the implications of this rule, trusts may realize income, losses, recapture, capital gains or capital losses and the related taxes without an actual liquidity event. This rule does not apply to a spousal trust, joint partner trust or alter ego trust as the deemed disposition of the property of these trusts is deferred until the later of the date of death of the settlor of the trust or their spouse as applicable (and every 21 years thereafter). Also, although relatively uncommon, this rule does not apply to property of a trust where all interests in the trust have vested. It should be noted that where property is transferred from one trust to another, the recipient trust will inherit the 21stanniversary date of the transferor trust. In addition, non-resident trusts (such as a US revocable living trusts) are also subject to 21st Anniversary Date Rule with respect to any Taxable Canadian Property (TCP) owned on each 21st anniversary date. This issue can be particularly troublesome in the case of Canadian real estate including cottages and chalets.
There are various alternatives available in order to mitigate the potential tax implications arising on the 21st anniversary date of a trust such as the following:
Where accrued gains do not exist, capital losses offset the gains or in certain cases, where the capital gains exemptions of the beneficiaries can be used, the trustees may allow the deemed disposition of capital property to occur so the assets will continue to be held under the control of the trustees.
Assets could be transferred to beneficiaries at cost, assuming the beneficiaries are resident of Canada and the provisions of subsection 75(2) of the Income Tax Act have never applied to the trust. Various matters must be considered with this strategy such as the loss of control of the assets by the trustees and the potential exposure of the assets to the claims of a beneficiary’s spousal and/or creditors.
If subsection 75(2) ever could have applied to the trust (say if a contributor of property to the trust has ever been a beneficiary or one of fewer than three trustees of the trust) and distributions are made by the trust to someone other than the contributor or their spouse, such distributions will take place at fair market value instead of cost (i.e. any gains in the distributed assets will be triggered). This result will also arise with respect to distributions of assets other than Canadian real estate to a non-resident beneficiary. A common example of an asset that can be particularly challenging in these cases are shares of a private company. There are various strategies that can be used to deal with these tax concerns. However, such planning takes time and must be anticipated well in advance of the 21st anniversary date of the trust.
If you haven’t already done so, we suggest that, while you are preparing trust returns (or filing your own) for the end of this month, you make note of and track the 21st anniversary dates of your trusts. Ideally any planning for the 21st Anniversary Date Rule should commence at least two or three years in advance of the actual date.
If you have any questions regarding the tax benefits of the use of trusts and planning for the 21st Anniversary Date Rule please contact your TSG representative.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.