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June 13, 2024

Tax Tips

Planning For the 21-Year Deemed Disposition Rule
Subject: Trusts
Number: 04-10
Date: 5/21/2004
Planning is required before the deemed disposition rules apply

Most inter-vivos trusts (trusts created during the creator's lifetime), with certain exceptions, are subject to the so-called "21-year deemed disposition" rule. In general, such a rule requires that the trust property be deemed to be disposed of at fair market value every 21 years from the anniversary date of the creation of the trust. To the extent that the trust property has appreciated significantly in value, such a rule can cause significant tax payable by the trust.

In planning with respect to a pending deemed disposition, one must look to see whether or not such trust property can be transferred to the capital beneficiaries of the trust on a tax-deferred basis. In many cases, such trust property can be transferred to the beneficiaries without any income taxes being payable. Accordingly, the 21-year deemed disposition rule can be avoided by the transfer of property to the underlying capital beneficiaries of the trust. A careful review of the trust deed must be done in order to ensure that such planning can be done.

One must also examine whether or not the trust has any capital losses that are being carried forward. To the extent that such losses exist within the trust, prudent planning may suggest a partial application of the 21-year deemed disposition rule so as to utilize such losses. The result would be that the trust's adjusted cost base of its properties could be increased as a result of the utilization of such losses thereby reducing income tax in the future when the property is actually disposed of.

Careful planning should be done well in advance of a potential application of the 21-year deemed disposition rule.

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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.