Business -> Capital gains exemption / Capital gains deduction

$750,000 Lifetime Capital Gains Exemption (LCGE) / $375,000 Lifetime Capital Gains Deduction

There is a $750,000 lifetime capital gains exemption (LCGE), which equates to a $375,000 lifetime capital gains deduction (1/2 of the $750,000 LCGE).  The deduction can be claimed against taxable capital gains on the disposal by an individual of:

The maximum LCGE that can be claimed by any individual was increased from $500,000 to $750,000, effective March 19, 2007, as a result of the 2007 Federal budget.  This includes exemptions for small business corporation shares, farm property, fishing property, and any capital gains exemptions used in 1994 or earlier.  The calculation of the deduction is done on CRA's form T657.

The rules relating to the capital gains exemption are complex, and professional advice should be obtained for anyone who is hoping to take advantage of this deduction.  Long term planning is necessary to ensure you qualify.  The following information includes only some general information.

a.    Qualified small business corporation (SBC) shares

Income Tax Act s. 110.6(1), S. 110.6(2.1)

An individual who owns shares in a qualifying small business corporation may be able to claim a $750,000 ($500,000 for dispositions occurring before March 19, 2007) capital gains exemption when those shares are sold.  There are 2 main rules, one regarding ownership of the shares, and the second regarding the use of the assets of the corporation.

1.    Throughout  the 24 months immediately preceding disposition of the shares, the shares must not have been owned by anyone other than the individual or a person or partnership related to the individual.  The shares may be newly-issued shares that have not been owned for a full 24 months, but they must not have been owned by anyone else in that time.

2.    Throughout the 24 months immediately preceding disposition of the shares, more than 50% of the fair market value of the assets of the corporation must have been used principally in an active business carried on primarily in Canada by the corporation or a corporation related to it.  At the time of disposition of the shares, all or substantially all (90% as per CRA) of the fair market value of the assets must have been used in the active business.  Examples of assets that may not qualify as being used in an active business are stocks, bonds, and rental property.

If the individual dies and has a deemed disposal of the shares, at the time of death the shares may  not be qualified small business corporation shares because of the 90% rule.  In this case, the Income Tax Act provides that the shares may still qualify, if the corporation was a qualified small business corporation at any time in the 12-month period before the death of the individual.

See also the CRA guide T4037 Capital gains.

When shares in an SBC are sold to a non-resident or to a public corporation, there could be a resulting denial of the capital gains exemption.  This is because s. 256(9) of the Income Tax Act deems that where control of a corporation is acquired, it is deemed to be acquired at the commencement of the business day.  The result is that when the shares are sold, they are deemed to be under the control of the purchaser, which is not a qualifying SBC.  A taxpayer can elect to have s. 256(9) not apply, but this could cause other complications.  A Federal Court of Appeal case dealing with s. 256(9) is La Survivance v. Canada 2006 FCA 129.  CRA issued Technical Interpretation 2006-0214781E5, which deals with s. 256(9) and the capital gains deduction.  It is imperative to get advice from a tax professional before making a sale of qualified SBC shares.

b.    Qualified farm property

Income Tax Act s. 110.6(1), S. 110.6(2)

An individual who owns farm property (land or building), an interest in a family farm partnership, or shares in a family farm corporation may be able to claim a $750,000 ($500,000 for dispositions occurring before March 19, 2007) capital gains exemption when the farm property is sold.  Qualified farm property of an individual includes property owned by:

The qualified farm property can be:

1.    real property or eligible capital property (such as production quotas) as long as it is used in the course of carrying on a farming business in Canada by:
        i.    the individual, or the spouse or common-law partner, parent or child of the individual,
        ii.    the beneficiary of a personal trust, or the spouse, common-law partner, parent or child of the beneficiary,
        iii.    a family farm corporation where any of the persons in i or ii above owns shares in the corporation, or
        iv.    a family farm partnership where any of the persons in i or ii above owns an interest in the partnership

2.    a share of the capital stock of a family farm corporation of the individual or the individual's spouse or common-law partner, or

3.    an interest in a family farm partnership of the individual or the individual's spouse or common-law partner.

There are rules about the period of ownership and the use of real property and eligible capital property in order to meet the qualified farm property requirements:

1.    throughout the 24 month period immediately preceding the disposition of the farm property, the property must have been owned by one of the persons listed in b(1) (i), (ii) or (iv) above, or by a personal trust from which the individual acquired the property, and

2.    one of the following requirements must also be met:
        i.    in at least 2 years while the property was owned the gross revenue earned from the farming business by one of the persons mentioned above must have exceeded the income of that person from all other sources for the year, or
        ii.    the property must have been used by a family farm corporation or partnership principally in the course of carrying on the business of farming in Canada throughout a period of at least 24 months during which time one of the persons mentioned above was actively engaged on a regular and continuous basis in the farming business in which the property was used.

If the farm property is real property that was acquired prior to June 18, 1987 and does not meet the above requirements, it still may qualify for the exemption.  To qualify, it must have been used by one of the persons mentioned above, principally in the course of carrying on the business of farming in Canada in the year of disposition, or in at least 5 years during which the property was owned by any of the persons mentioned above.

If the farm property is also the taxpayer's principal residence, the capital gain on disposal may be divided into principal residence and farm property.  The principal residence exemption would then be calculated for the principal residence portion, and the $750,000 capital gains exemption used for the farm property.

More information on qualified farm property can be found in the CRA guide T4003 Farming Income.

c.    Qualified fishing property

The May 2006 federal budget made the $750,000 ($500,000 for dispositions occurring before March 19, 2007) capital gains exemption available for qualified fishing property, for dispositions occurring on or after May 2, 2006.  For more information on what is qualified fishing property, see capital gains of fishers in the federal budget documents.

d.    Cumulative net investment loss (CNIL)

When the capital gains deduction is calculated, it is reduced by the taxpayer's CNIL balance.  The CNIL balance is the amount by which the total of all investment expenses exceeds the total of all investment income for all tax years after 1987.  The CNIL can be calculated by filling in CRA's form T936 for each year after 1987.

Tax tip:    This is complicated and can save up to $100,000 in taxes - do it right and get professional advice!

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Revised: September 06, 2009