LIFETIME CAPITAL GAINS EXEMPTION

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

The Lifetime Capital Gains Exemption is an essential tax planning tool for Canadian small business owners, farmers and fishers, who need to optimize its use in conjunctition with other tax planning strategies, given the finite amount assigned to the Lifetime Capital Gains Exemption. The Lifetime Capital Gains Exemption allows qualifying Canadian businesses to reduce or eliminate the capital gains tax on the sale of specific types of property.

A. Exemption Amount

The Lifetime Capital Gains Exemption has a cumulative lifetime limit per individual. As of June 25, 2024, the exemption limit for qualified small business corporation shares and qualified farm or fishing property was increased to $1.25 million. This amount is indexed to inflation, with annual indexation scheduled to resume in 2026. This means that an individual can claim this deduction on one or more qualifying sales until they have reached the maximum lifetime limit.

B. Qualifying Property

The Lifetime Capital Gains Exemption only applies to the disposition of certain types of property:

  • Qualified Small Business Corporation Shares: These are shares of a Canadian-controlled private corporation that meet specific criteria related to the use of its assets.

  • Qualified Farm or Fishing Property: This includes real estate, fishing vessels, and licenses used in a farming or fishing business.

C. Eligibility Criteria

To be eligible for the Lifetime Capital Gains Exemption, several conditions must be met:

  • Canadian Residency: The individual claiming the exemption must be a resident of Canada throughout the year of the disposition.

  • Ownership Period: For qualified small business corporation shares, the individual (or a related person or partnership) must have owned the shares for at least 24 months before the sale.

  • Asset Use:

    • 24-month period: For the 24 months immediately preceding the sale, more than 50% of the fair market value of the corporation's assets must have been used in an active business carried on primarily in Canada.

    • At the time of sale: At the time of the sale, at least 90% of the fair market value of the corporation's assets must be used in an active business carried on primarily in Canada.

D. Mechanics of Lifetime Capital Gains Exemption

When a qualifying property is sold, the capital gain is calculated as the proceeds of disposition minus the adjusted cost base. In Canada, a portion of the capital gain is considered taxable income. The Lifetime Capital Gains Exemption allows you to deduct an amount from your capital gains, thereby reducing your taxable income.

As such, where a business owner sells their qualified small business shares for a capital gain of $1.75 million, they could use the Lifetime Capital Gains Exemption to shelter a portion of that gain from tax. With a $1.25 million exemption, they would only have to pay tax on the remaining $500,000 of the gain.

E. Key Considerations on Lifetime Capital Gains Exemption

  • Planning is Crucial: Meeting the eligibility requirements, particularly the asset and ownership tests, often requires advance planning. It may be necessary to restructure the business or sell non-qualifying assets before a sale to ensure the corporation meets the criteria. Also, given the finite nature of the lifetime capital gains exemption, alternate tax strategies might be more appropriate for a particular business disposition (e.g., employee-ownership trusts).

  • Cumulative Net Investment Loss: There may be the potential to reduce one's capital gains deduction through the application of one's cumulative net investment loss. Once again, given the finite nature of the lifetime capital gains exemption, utilizing other available tax minimization tools to effectuate the permissible reduction of taxes should be considered as part of an overall tax planning strategy.

  • Professional Tax Consultation: The rules for the Lifetime Capital Gains Exemption are complex. It is highly recommended to seek advice from a tax professional to determine eligibility and to plan a disposition to maximize the benefit of the exemption, while considering other available tax planning options to determine the best long-term strategy for the particular transaction.

For knowledgeable and experienced legal representation for strategic tax planning, including the optimization of the lifetime capital gains exemption, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

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