Spousal Trust — Defer Capital Gains Tax on Appreciated Assets Until a Surviving Spouse Dies

What Is It?

When a Canadian dies, the Income Tax Act (s. 70(5)) deems them to have disposed of all capital property immediately before death at fair market value. This triggers capital gains tax on all appreciated assets — payable by the estate. On a large investment portfolio or a cottage property, this “death tax” can be hundreds of thousands of dollars.

A spousal or common-law partner trust (under s. 70(6)) provides an important exception: assets can roll over to a qualifying trust for a surviving spouse or common-law partner at the original adjusted cost base (ACB), deferring capital gains until the trust disposes of the assets or the survivor dies. No capital gains tax is triggered at the time of death.

Do I Qualify?

• You have appreciated non-registered assets that could trigger major capital gains at death
• You have a surviving spouse or common-law partner you want to support
• You want deferral without giving the surviving spouse complete unrestricted control of the assets
• Your will can be drafted to satisfy the strict spousal-trust rollover conditions

What Qualifies as a Spousal Trust

For the tax-free rollover to apply, the trust must meet these conditions:

1. The trust is created by will or by the operation of a spousal testamentary trust
2. The surviving spouse must be entitled to receive all income of the trust during their lifetime
3. No one other than the spouse may benefit from the trust during the spouse’s lifetime
4. The trust is resident in Canada

These are strict conditions — even minor trust provisions allowing capital distributions to children during the spouse’s lifetime can disqualify the trust.

How the Rollover Works

Without a spousal trust:

• Deceased spouse’s portfolio of $800,000 (ACB $200,000) triggers a $600,000 capital gain
• 50% inclusion rate = $300,000 of taxable income
• Tax at 53% marginal rate (Ontario example) ≈ $159,000 paid by the estate

With a qualifying spousal trust:

• Portfolio rolls over to the trust at ACB ($200,000)
• No capital gains at death
• Capital gains are deferred until the survivor disposes of assets or dies
• Estate retains the full $800,000 (minus probate fees) for the survivor’s benefit

What Happens When the Surviving Spouse Dies

When the surviving spouse dies (or the trust ceases to qualify), the trust is deemed to dispose of all its property at fair market value at that point — triggering capital gains tax on the appreciation since the original deceased spouse’s ACB. The deferral ends, but has potentially provided decades of tax-free compounding.

What Most People Don’t Know

• Probate may still be triggered. Assets in a testamentary spousal trust typically pass through the estate and may be subject to provincial probate fees (estate administration tax). Only assets transferred by direct designation (RRSP, RRIF, TFSA beneficiary designations, joint tenancy) bypass probate.
• The trust must be properly drafted. Even small drafting errors — like allowing capital distributions to children for “emergencies” — can disqualify the spousal trust status and trigger immediate capital gains. Always use an estate planning lawyer.
• The survivor can use trust income freely. While trust capital is retained, the survivor receives all income annually. This provides ongoing financial support while preserving the underlying assets for eventual distribution to beneficiaries.
• The spousal trust is different from a spousal RRSP rollover. RRSP/RRIF assets can be transferred to a surviving spouse at cost (as income, not capital gains) through a different rollover provision — this is separate from the spousal trust mechanism for non-registered assets.

Frequently Asked Questions

Sources

• Income Tax Act — s. 70(5), 70(6), 104–108 (Trusts)
• CRA — Testamentary Spousal or Common-Law Partner Trusts
• Law Society — Estate Planning with Trusts