From Wikipedia (TTC page):
The tracks of Toronto's streetcars and subways are built to the unique track gauge of 4 ft 10 7⁄8 in (1,495 mm), 2 3⁄8 in (60 mm) wider than the usual standard gauge of 1,435 mm (4 ft 8 1⁄2 in), which the Scarborough RT uses. According to Steve Munro, an expert on the history of Toronto area transit, TTC gauge is "English carriage gauge".
That the gauge of the said railways shall be such that the ordinary vehicles now in use may travel on the said tracks, and that it shall and may be lawful to and for all and every person and persons whatsoever to travel upon and use the said tracks with their vehicles loaded or empty, when and so often as they may please, provided they do not impede or interfere with the cars of the party of the second part (Toronto Street Railway), running thereon, and subject at all times to the right of the said party of the second part, his executors, and administrators and assigns to keep the said tracks with his and their cars, when meeting or overtaking any other vehicle thereon.
As wagons were normally built at standard gauge, the streetcar rails were selected to be slightly wider, allowing the wagons to ride on the inside sections of the rail, and the streetcars on the outside. The Williams Omnibus Bus Line changed the gauge of their buses in 1861 to fit this gauge. At the time, track for horsecars was not our modern 'T' rail, but wide and flat, with a raised section on the outside of the rail.
According to the TTC, the City of Toronto feared that the street railway franchise operator, first in 1861, the Toronto Street Railway, then in 1891, the Toronto Railway Company, and in 1921, the TTC, would allow the operation of steam locomotives and freight trains through city streets, as was common practice in Hamilton, Ontario (until the 1950s) and in many US cities, such as New York City and Syracuse, New York.
Standard gauge rails in the streets would have allowed this, but steam railway equipment could not follow the abrupt curves in the streetcar network. Opposition to freight operation in city streets precluded interchange even with adjacent radial lines even after the lines changed to TTC gauge. Electric railway freight cars could negotiate street curves, but freight operations to downtown were still not allowed until the final few years of radial operation by the TTC.
The unique gauge has remained to this day since converting all tracks and vehicles would be expensive and would lack any real benefit anyway. Some proposals for the city's subway system involved using streetcars in the tunnels, possibly having some routes run partially in tunnels and partially on city streets, so the same gauge was used, but the idea was ultimately dropped in the case of dedicated rapid-transit trains. The use of standard-gauge tracks on the Scarborough RT makes it impossible for there to be any track connection between it and the other lines, and so when RT vehicles need anything more than basic service (which is carried out in the RT's own McCowan Yard), they are carried by truck to the Greenwood subway yards.
The proposed Eglinton Crosstown LRT line will be constructed to standard gauge. As the project is receiving a large part of its funding from Metrolinx, the Ontario provincial transit authority, it wants to ensure a degree of commonality with any other proposed tram/LRT projects within Ontario to ensure a better price for purchasing vehicles.