21-Year Tax Issues And The Non-Specialist Advisor— Part 1

Author:Mr Michael A. Goldberg
Profession:Minden Gross LLP
 
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What To Do When Your Trust Comes of Age

Although I can barely remember it any more, turning 21 is a big deal! For example, when you turn 21 pretty much everyone thinks of you as an adult, and if you haven't already done so, you can go to university, go to bars around the world, and move out of your parents' house—though I didn't move out until I was 27.

Well, in Canada, when a trust turns 21, it's a big deal too—principally because when a trust turns 21 it will be deemed to have disposed of many of its assets at their fair market value ("FMV"), which for trusts that hold valuable property can give rise to a hefty tax bill. The purpose of this four-part series of articles ("Series") is to help prepare your clients for their trusts' "coming of age" and, in particular, to help them manage the "21-year deemed disposition rule."1

What is the 21-Year Deemed Disposition Rule?

Although the 21-year deemed disposition rule is often referred to in the singular, it is actually a series of rules that deems there to be a disposition (and reacquisition) of trust property at FMV. As a result, throughout the Series these rules will be referred to as the 21-year deemed disposition rules.

In particular,

Subsection 104(4) of the Income Tax Act (Canada) ("Act")2 —deals with the deemed disposition of capital property; Subsection 104(5)—deals with the deemed disposition of depreciable property; and Subsection 104(5.2)—deals with the deemed disposition of resource property. Without these rules, trust property could effectively pass from generation to generation to generation, and so on, without tax.

The 21-year deemed disposition rules cause a trust to be deemed to have disposed of the aforementioned types of property at FMV, which gives rise to the deemed realization of capital gains or capital losses as well as ordinary income or losses, including recaptured capital cost allowance. Interestingly, rules that would deny non-arm's length loss realization, the so-called superficial loss rules, do not apply to 21-year deemed dispositions.3

Exceptions to 21-Year Deemed Disposition Rules

It is possible to "elect" to pay the deemed disposition tax over no more than ten years.4 However, it is only possible to make this election in respect of capital property—not depreciable property or resource property.

Also, although the making of the election seems like a good idea, in practice the decision to make the election can be more complicated. The Canada Revenue Agency ("CRA") requires "acceptable" security to be...

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