The twenty-one-year rule, under subsection 104(4) of the Income Tax Act, deems most trusts to dispose of their capital property at fair market value every twenty-one years. The deemed disposition crystallizes accrued capital gains at the trust level, even though the trust has not sold anything, preventing indefinite tax deferral inside a trust.
Certain trusts, such as qualifying spousal trusts during the spouse's lifetime, are exceptions. Long-term family trusts must plan ahead of the twenty-one-year anniversary. A common approach is to distribute the trust's capital property to capital beneficiaries on a rollover basis before the anniversary, deferring the gain to the beneficiaries, although this depends on beneficiary residency and the terms of the trust. The alternative is to accept the deemed-disposition tax.