In 1986, the Lifetime Capital Gains Exemptions was introduced by the CRA. By understanding how it works and how to qualify for it, you can significantly lower your tax bill. We’ll take a look at how CGE works.
Do you qualify for Capital Gains Exemption (CGE)?
If you buy a capital asset for your business and then later sell it at a price that is much higher than the purchase price, you’re required to pay capital gains tax on the profit you make. However, the CRA introduced the LCGE, which is a tax exemption that enables you to avoid paying this tax up to $800,000 on total gains. But not all assets are eligible for capital gains exemption. Assets such as farm property, fishing property and shares of qualified small business corporations may be eligible for this tax exemption. This tax exemption was introduced in order to encourage people to invest in more productive assets.
An example of LCGE
Whenever you make capital gains, the CRA requires you to pay taxes on 50% of the gained amount. However, if the asset you sold qualifies for LCGE, you can claim an exemption of up to $800,000 of the taxable amount. For instance, if you sell an asset that qualifies for LCGE and get a profit of $1,000,000, the CRA allows you to pay tax on 50% of the gains which is $500,0000 of this amount.
Rules to qualify for LCGE
The CRA has set aside strict rules to ensure the asset qualifies for this tax exemption. Small businesses that are allowed to use this tax exemption must be Canadian-controlled private corporations. Also, since LCGE applied to individuals only, you must be a resident of Canada the entire tax year. For the properties listed, it is required that you, your spouse or partner be the owner. Bear in mind that cumulative net investment losses can reduce the amount of exemption you can claim.
The beauty of LCGE is that the savings are spread over the entire lifetime which leads to huge tax savings over the years. Also remember that, for an asset to qualify it must be used in an active business that is conducted primarily in Canada. There are assets such as goodwill and patents that may not be listed on the balance sheet but qualify for this tax exemption.
The CRA must determine if the disposed share was owned by the shareholder or a related person for at least 24 months before the disposition. This rule has been set aside by the tax authorities to prevent the habit of flipping investments and ensure the tax exemption only caters to longer-term investments.
Common CGE strategies such as transferring capital gains in a trust and allocating it to different family members no longer work. Capital gains that are accrued to individuals who are below 18 years of age no longer qualify for CGE. The federal government made these changes to curb income splitting by business owners who are looking to lower their tax bill.
Sohail Afzal, CPA, CMA, MBA
Sohail Afzal, (CPA, CMA, MBA) is the founder & CEO of GTA Accounting Professional Corporation. He is a highly experienced Chartered Professional Accountant and businessman himself and understands the challenges that many businesses face when it comes to cash flow management. As an experienced business consultant & tax advisor, he is helping companies grow by providing the technical, financial, and contractual information necessary for strategic decision-making.