Each Canadian is entitled to a capital gains exemption on certain small business shares, as well as on qualified farm and fishing properties. The Canada Revenue Agency refers to the exemption as a lifetime capital gains deduction, whereby the capital gain, which is 50% of the total gain, is still included as income for tax purposes. However, an offsetting deduction from net income is allowed when you are calculating taxable income.
Small Business Shares
For the $848,252 (in 2018) exemption, shares must meet the definition of a qualified small business corporation.
- No one but the owner or a person related to him can have owned the shares for the two years before he sells them.
- Substantially all, which is considered by the CRA to mean 90 percent or more of the value, of the business’ assets must be used for carrying on an active business in Canada or be shares and debt in other small business corporations.
- Throughout the two-year period, more than 50 percent of the corporation’s assets must have been used primarily in an active business in Canada.
If you plan to sell or transfer shares to children of a small business owner who you believe would or could qualify, a common strategy is to “purify” the company prior to the sale. This includes taking action to dispose of or change the structure of the company to meet the definitions above.
It is also possible to transfer the assets of a business that you carry as a sole proprietor to a corporation on a tax-free basis in order to take advantage of the exemption. This is known as a section 85 rollover and serves to lock in the gain as the assets are transferred at a higher value into the corporation. If the company plans to go public, there is also an election that allows for the actual use of the exemption.
Qualified Farm and Fishing Property
Similar to the qualified small business corporation condition, if you owned a property used in a family farming or fishing business over two years before you sell it, and continue to use it on a regular basis, you might be able to use your capital gains exemption against the sale. However, the income earned from your farming or fishing business must be greater than any income that you earned from other sources. The LCGE limit for qualified farming and fishing property is $1,000,000 for tax years 2015 to 2018.
The capital gains exemption is reduced if you have any allowable business investment losses.
- Those losses should be netted against your taxable capital gains first
- You are not able to claim them both.
There are also specific rules concerning the use of the gain if you have a Cumulative Net Investment Loss (CNIL). The CNIL relates to interest expenses you wrote off against investment income, and these expenses also decrease your exemption. With numerous rules and criteria in place for both ABIL and CNIL, you should be sure to do more research or check with a qualified tax professional before claiming such exemptions.