Personal trusts are set up for various purposes. Often, they are set up by a “settlor” who puts property in trust for an individual or individuals, known as the “beneficiaries” of the trust. For income tax purposes, a trust is considered a separate person, and is a “taxpayer” that may be subject to tax, tax return filing obligations, and other requirements under the Income Tax Act.
Transfers of property into a trust
Unless one of the exceptions discussed below applies, if you transfer property into a trust, you will normally have deemed proceeds of disposition equal to the fair market value of the property. As such, you may realize a capital gain or income if there is an accrued gain in respect of the property. (If there is an accrued loss, you will sometimes be denied the loss under the “superficial loss” rules in the Income Tax Act.)
Tax-free rollovers into trusts
On the other hand, if you transfer property to the following types of trusts, there will be a taxfree rollover, meaning that you will have deemed proceeds of disposition equal to your tax cost of the property and therefore no capital gain or income. The trust will inherit your tax cost of property.
The trusts that qualify are:
- A spousal trust. Basically, this is a trust under which your spouse (or common-law partner) is a beneficiary who is entitled to all of the income of the trust during his or her lifetime, and no one else may obtain any of the capital of the trust during the spouse’s lifetime.
- A joint spousal trust. You must be at least 65 years old to set up this trust. This is a trust under which you and your spouse (common-law partner) are beneficiaries who are entitled to all of the income of the trust until the later of your deaths, and no one except you and your spouse can obtain any of the capital of the trust until the later of your deaths.
- An alter ego trust. You must be at least 65 years old to set up this trust. You as a beneficiary must be entitled to all of the income of the trust during your lifetime and no one else can obtain any of the capital during your lifetime.
- A “protective” trust. Basically, this is a trust where the transfer of the property does not result in change in beneficiary ownership of the property – meaning that you retain all beneficial aspects of ownership and no other beneficiary does.
Although there is an automatic tax-free rollover for transfers to these trusts, you can elect out of the rollover, in which case the fair market proceeds rule normally applies. The election out of the roll-over may be beneficial if you have tax losses that can offset any accrued gains from the fair market disposition of the property, since the trust will have a bumped-up cost equal to the fair market value.
Distributions of property out of a trust
Most distributions of property out of a personal trust take place on a tax-free rollover basis. Most family and private trusts are set up as personal trusts. However, the technical requirement for personal trust status is that no beneficial interest in the trust can be acquired for consideration payable either to the trust or to a person who contributed to the trust.
There are some situations where the rollover does not apply, including:
- Where the property is distributed to a beneficiary who is not resident in Canada;
- Where the trust was a “revocable” or “reversionary” trust under which the settlor could obtain back the property he or she transferred to the trust;
- Where the trust elects out of the rollover; and
- Where the trust is a spousal trust, joint spousal trust or alter ego trust (see above), and the property is distributed to a person other than life beneficiary under the trust (e.g. you, your spouse, etc.).
Where the rollover does not apply, the distribution of the property will give rise to proceeds of dispo-sition of the property equal to its fair market value. This may result in a capital gain or other income.