In most cases, the Canada Revenue Agency requires you to pay tax on income earned from capital gains. However, gains arising from the disposition of certain qualifying assets are immune to the taxation requirement. Instead, you can offset that income with the Lifetime Capital Gains Exemption.
Capital Gains Eligible for the Deduction
Only certain capital gains are eligible for the deduction. These include gains arising from the disposition of qualified small business shares, or qualified farm or fishing property. In order to claim this deduction, you must be a resident of Canada at the time of the disposition.
If you have capital gains from the disposition of publicly traded shares or mutual funds, they are not eligible for the deduction.
When you give away or sell an asset, you have disposed of it. In most cases, to calculate your capital gains, you take the sale price of the asset and subtract its adjusted cost base (the purchase price plus any costs incurred when buying it).
However, if you sell the asset for less than the fair market value or if you give it away, you cannot use the sale price to determine your capital gains. Instead, the CRA requires you to use its Fair Market Value (FMV).
For example, if you gave a house to your son, you have to calculate your capital gains as if you sold the house for its FMV. You must also pay tax on these capital gains. In contrast, if you give your son qualified small business corporation shares, you still calculate your capital gains using the FMV of the shares. However, you wouldn’t be required to pay tax on those gains as a result of the capital gains deduction.
Defining Qualified Small Business Shares
The CRA has a number of requirements defining which small business corporation shares are eligible for the capital gains deduction. To qualify, the shares must have been owned by you, your relative or your partnership for 24 months prior to the sale. Additionally, the company must be a Canadian-controlled private corporation and must carry out most of its business in Canada.
Defining Qualified Farm or Fishing Property
Qualified farm property includes land, buildings, capital stock in family-farm corporations, interest in family-farm partnerships, and capital property such as milk or egg quotas. Qualified fishing property includes land, sea vessels, and eligible capital property such as fishing licenses.
If you have a capital gain from the sale of any of these items, this amount may be eligible for the capital gains deduction. To qualify, the item must have been owned by you, your spouse or common-law partner, or a family-farm partnership in which either you or your spouse or common-law partner has an interest, prior to its disposition.
Lifetime Capital Gains Exemption
Unfortunately, the CRA does not allow you to claim an unlimited amount of capital gains deductions. However, in 2014, the agency increased the Lifetime Capital Gains Exemption limit and indexed it to inflation.
The LCGE is $883,384 for qualifies small business shares. That means qualifying capital gains up to that limit are exempt from taxation. However, since the CRA only taxes half of all capital gains, this limit equates to a deduction of up to $441,692. For qualified farming and fishing property, the LCGE was raised to $1,000,00 which equates to a deduction of up to $500,000.
If you are applying the LCGE to capital gains from previous years, the LCGE for 2014 was $800,000. For property disposed of after March 18, 2007, and before 2014, the exemption is $750,000. For property disposed of between 1985 and March 18, 2007, the exemption is $500,000. These amounts equate to a $375,000 and $250,000 deduction, respectively.
Claiming the Deduction
In order to claim your capital gains exemption, complete Schedule 3 of your federal income tax return. This schedule helps you calculate your capital gains. If you are reporting a reserve from a previous year, you must also complete Form T2017 – Summary of Reserves on Dispositions of Capital Property.
To determine the amount of your exemption, use Form T657 – Calculation of Capital Gains Deductions. This form will help you determine whether the property you disposed of meets the criteria for the exemption.
Next, the form prompts you to enter information about your current capital gains, net capital losses from previous years and allowable business investment losses. It instructs you to enter these numbers in a formula that determines your exemption for the year.
Capital Gains and Gifts
If you donate certain capital assets to qualifying charities, you do not receive a deduction. However, the CRA offers you an inclusion rate of zero percent. Ultimately, this has the same effect on your taxes.
If you have given shares, ecologically sensitive land, or a range of other capital assets to a qualifying charity, you must still calculate your capital gains using the FMV of the asset. As a result of the inclusion rate of zero percent, you don’t have to report these gains.