Introduction to Lifetime Capital Gains Exemption
Generally, where a taxpayer disposes of capital property—such as corporate shares—and realizes a capital gain, the taxpayer must include one-half of the gain in his or her income. But if the disposed property is either a qualified small-business-corporation share (QSBC share) or qualified farm or fishing property, the gain may be deductible under Division C of the Income Tax Act when computing the taxpayer’s taxable income.
This article recounts briefly the history of the lifetime capital gains exemption, describes generally which taxpayers qualify for the exemption, and explains the main requirements of a QSBC share and qualified farm or fishing property.
Brief History of the Lifetime Capital Gains Exemption in Canada
Parliament introduced this lifetime capital gains exemption (LCGE) in 1985. It provides every individual residing in Canada with a lifetime exemption from tax on a certain amount of net capital gains. Originally, an individual received an exemption of up to $500,000 on net taxable capital gains realized from any capital property that the individual disposed after 1985 and before death or emigration.
In 1985, Parliament allowed the full $500,000 exemption for qualified farm property, but it would gradually phase in the exemption for other capital property, which would remain capped at $100,000. In 1988, qualified small-business-corporation shares also qualified for the $500,000 lifetime capital gains exemption Eight year later, in 1996, Parliament repealed the $100,000 LCGE applying to capital property other than qualified farm property and QSBC shares. It also extended the $500,000 LCGE to qualified fishing property.
Effective for 2014 and subsequent taxation years, the lifetime capital gains exception amount for qualified small-business-corporation shares is $800,000. Indexed for inflation, the exemption is $835,716 in 2017. For tax years ending after April 20, 2015, the LCGE amount for qualified farm or fishing property is $1 million. This amount is not indexed for inflation.
Qualifying for the LCGE: An Individual Who is Resident in Canada
Individuals—as Opposed To Corporations—qualify For The LCGE. To Qualify, An Individual Must Be A Resident In Canada Throughout The Tax Year In Which The Individual Claims The Capital Gain Deduction.. For this purpose, subsection 110.6(5) of the Income Tax Act deems certain part-year residents to have been resident in Canada throughout the year in which they either immigrated to or emigrated from Canada. In addition, subsection 110.6(13) excludes from computing the LCGE the capital gains or losses that an individual realized while a non-resident.
If you have questions about your residence status, please consult one of our expert Canadian Tax Lawyers.
Shares of a Qualified Small Business Corporation
Subsection 110.6(1) of the Income Tax Act provides a complex definition of a QSBC share. But, at bottom, a qualified small-business-corporation share must meet three requirements:
- (1) an asset requirement,
- (2) an ownership requirement, and
- (3) a mixed asset-and-ownership requirement.
Under the asset requirement, the share must be that of a “small business corporation,” which is a Canadian-controlled private corporation using at least 90% of its assets in an active business in Canada. The target share must meet the asset requirement at the time when it must qualify as a QSBC share for the purpose of the LCGE—that is, the share must satisfy the asset requirement at the time of disposition.
Under the ownership requirement, no one other than the claiming individual or a person or partnership related to that individual may own the QSBC share throughout the 24 months preceding the share’s disposition. In other words, throughout the 24-month period prior to the relevant disposition, the QSBC share must be owned by either (i) the individual claiming the LCGE or (ii) an individual, partnership, or corporation related to that individual.
Finally, the mixed asset-and-ownership requirement demands that, throughout the 24-month period preceding the QSBC share’s disposition—that is, during the period that either the claiming individual or a related person owned the share—the share was that of a Canadian-controlled private corporation using at least 50% of its assets in an active business in Canada.
Planning advice from one of our skilled Canadian Tax Lawyers can ensure that you meet these requirements.
Qualified Farm and Fishing Property
Subsections 110.6(1) and 110.6(1.3) set out the elaborate requirements of qualified farm or fishing property. This section of the article provides a general overview of these requirements.
Qualified farm or fishing property includes:
- – a real property;
- – a fishing vessel used in a dishing business;
- – a share of the capital stock of a family-farm or family-fishing corporation;
- – an interest in a family-farm or a family-fishing partnership; or
- – an eligible capital property used in a farming or fishing business in Canada.
As with the requirements of a QSBC share, the Income Tax Act imposes an ownership requirement upon qualified farm or fishing property. In particular, throughout the 24 months preceding its sale, the property must have been owned by either the LCGE-claiming individual; the individual’s spouse, common-law partner, child, or parent; a personal trust; or a family-farm or family-fishing partnership.
Likewise, qualified farm or fishing property must meet requirements analogous to the asset and mixed asset-and-ownership requirements demanded of QSBC shares. For example, to pass as qualified farm or fishing property, real property must have been mainly used in a farming or fishing business in Canada throughout the 24-month ownership period.
Two common tax tips relating to the LCGE are purification and crystallization. Purification is used to ensure that a corporation’s shares meet the QSBC asset test—thus qualifying those shares for the lifetime capital gains exemption. Recall, a qualified small-business corporation must devote at least 90% of its assets to an active business. So, shares will fail to qualify for the lifetime capital gains exemption if more than 10% of the owned corporation’s assets consist of, say, investment property. One “purifies” the corporation by ridding it of the disqualifying assets.
On the other hand, one might wish to trigger a disposition of QSBC shares and thus “crystallize” his or her LCGE. This technique commonly comes into play during an estate freeze, a transaction employed to minimize capital-gains tax on death.
Tax planning advice from one of our top Canadian Tax Lawyers can allow you to benefit from these tax tips to ensure that you reduce capital gains when you sell your shares.