6 quick facts about the capital gains exemption in Canada

Yesterday I was visiting my parents back home on the farm and enjoying a lazy Saturday afternoon away from the big city. In exchange for some really great ice cream, my Mom asked me for some tax advice related to the lifetime $500,000 capital gains exemption.

Long story short, she was under the impression she could shield any and all capital gains using the exemption. Unfor­tu­nately, the exemption is very specif­i­cally targeted and is not a blanket exemption for just any gain.

So, a rundown of the basic facts surrounding this oft-misunderstood tax tidbit.

  1. Share sales qualify for the exemption if and only if they are of a Small Business Corpo­ration, which is defined in the Tax Act as being a Canadian-Controlled Private Corpo­ration with generally 90% of its assets involved in active business.
  2. The shares must have been owned by you or a relative for a 24-month period prior to the sale, and for that same period at least 50% of the assets must have been used in active business in Canada.
  3. Steps should be taken to “purify” the corpo­ration to take advantage of the exemption. This normally means removing invest­ments held by the corpo­ration, as these are assets not used in its active business and could thus violate the 50% and 90% rules above.
  4. The 2007 budget proposed increasing the lifetime exemption from $500,000 to $750,000, and proposes to take effect for dispo­si­tions after March 18, 2007.
  5. Unincor­po­rated businesses — sole propri­etor­ships or partner­ships — are not eligible to use the exemption, which is a prime benefit to incor­po­ration. There are ways to roll business assets into a newly formed corpo­ration not resulting in tax.
  6. You can “crystallize” the exemption at a time when the corpo­ration qualifies, which involves trans­ferring the shares to a holding corpo­ration and electing to recognize a gain. In case the government decides to eliminate or change the exemption, you’ve already taken advantage and are protected.

As with any general tax infor­mation, your situation will be unique. You should definitely seek out a Chartered Accountant to review your personal situation and prepare a plan tailored to you. If you need a CA, please contact me and I can provide some recommendations!

21 thoughts on “6 quick facts about the capital gains exemption in Canada”

  1. If i have a corpo­ration that is basically sitting on a lot of cash is there a way to convert it so that I can seel the company at a modest discount and then materi­alize the cash as a capital gain as capital gains exempt smalll business?
    I saw that rental properties are excempt which i thought would be a simple thing to do.

  2. Hi there
    I am so very lost about capital gains
    I have a piece of property that I am pondering about selling and wondering what I can expect regarding capital gains.
    The 1031 that appears on US sites…do we have this in Canada or something similar
    Please help!

  3. Scott, the type of trans­action you’re describing is what is known as “non-arm’s length”. I think you’re talking about selling the company “at a discount” because you’re not truly selling the company to an unrelated third party, which would be an “arm’s length” party. You’d be selling the company for a price below its fair market value. There are rules that prevent this type of avoidance.

    As well, rental properties earn “passive income”, which may be the reason for the different treatment.

    Lynn, I’m sorry I’m not more familiar with US tax forms, but I think it is safe to say the principles behind capital gains are the same both in the US and Canada. See my post about the principle residence exemption, if it applies.

  4. Neil,
    Being a dufus when it comes to taxes and numbers,I’ve read your capital gains info with interest.What I can’t seem to find is some info on the current government’s plan to exempt capital gains for 6 months if it is re-invested.
    My situation is I purchased an apartment(now worth twice what I paid for it) that two of my kids live in and I would like to sell the apartment and get a townhouse.Of course I don’t want to pay any capital gains if I don’t have to.
    There is no urgency to sell,but I don’t know what happened to the “promise” from the current government.What have you heard or know about this election promised “six month rule”.
    Enjoy reading your info.
    –George

  5. George — Initi­ially, I thought your situation would fall under the “replacement property” rules. When I looked into it, however, it appears that those rules govern the sale and replacement of business property only. I don’t think there is an equiv­alent rule for residential property.

    The only mechanism to defer/reduce capital gains on residential property I know of for sure is the principal residence exemption, which probably doesn’t apply in this situation if you live somewhere else and your kids just live in the apartment.

    I haven’t heard of anything the current government may be proposing to do in terms of replacement of residential property.

    Thanks for commenting! :)

  6. I should’ve linked to the post on the principal residence exemption instead of just mentioning it. I guess it may be worth­while if the property increases in value in really short time and he hasn’t owned it long, so something like living there 1 of 3 years saves 33% of the gain. Plus what if the current property has gains too?

  7. Neil,
    I’ve located the government “promise” as stated during the election campaign.

    http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20060206/SUB/602060709/-1/INIssueAlert04

    Prime Minister Stephen Harper won a minority government Jan. 23 partly due to a platform, called Stand Up for Canada, which included a promise to cut taxes on capital gains for individuals and companies that reinvest the money within six months.

    Current capital gains rules require investors to report 50% of profits as income.

    This will allow those who sell family enter­prises to avoid taking a hit, and it will keep longer-term investors focused on longer-term gains,” Mr. Harper said during the campaign.

    Canadians who invest, or inherit cottages or family heirlooms, should be able to sell those assets and flow their profits back into the economy without taking a tax hit,” said the Conser­v­ative election platform. Gains from real estate would be included, as well as stocks, bonds and mutual funds.“
    What ever became of this?
    –George

  8. Harper’s promise was fulfilled, actually — key word is “family enter­prise”. the heirlooms/cottages part is unrelated to the fact that the lifetime capital gains exemption is increased to $750k now.

    I don’t recall if there was anything said about inher­i­tance taxes.

    As for that second part of their platform, I’d have to see the full context to see what they’re referring to exactly. Either they’re referring to something else, or they could try and weasel out of the specific examples by pointing to this or that particular thing. Without the full text it’s hard to make a good interpretation.

  9. Neil,
    Our situation is almost the opposite of George’s. We has a 5% share of the title of our principal residence, while 95% lies with my non-resident father-in-law. He has indicated the balance of the title will transfer to us when he passes away. At that time, will we be able to avoid the capital gains because we are on the titale and this is our principal residence, or are we going to get hit hard on the 95% that is in his name?

  10. Hmm, depends on the juris­diction you live in and what the nature of inher­i­tance taxes is versus the ability to outright “gift” full value of the property instead, as well as the rules in the probate laws that affect you.

  11. We just sold our principal residence last Nov, 2007. We had a basement suite that we had rented out for the 3 years we owned the house. Each year we claimed the rental income on our taxes. Do we still have to pay capital gains???

  12. Assuming you didn’t claim depre­ci­ation on your house (unlikely), you’re probably exempt (unless there’s other details we’re not aware of, etc. etc.).

  13. Had a mobile home which “kids” used while going to school–no rent. Sold for twice the amt. I paid. in 2002..Do I have to claim capital gains on the total gain and if so what rate?
    Also sold a commercial building that we put up in 1973. Do we have to claim capital gains on the difference of the value from 1973 to present?or on the FMV
    Thanks

  14. Sandy, if your taxes work like in our juris­diction, you’re probably going to pay c.g., which means you pay tax on half the gain at whatever tax rate you find yourself at. Your tax return should help you calculate that.

    The 1973 question is a bit compli­cated because of various factors.

    You should definitely get a local profes­sional accountant to advise you. I imagine you made a substantial profit on the sale of your building. You wouldn’t risk losing a large portion of that to the government as they definitely follow such things carefully. It’s worth your time to consult with a local tax profes­sional to avoid getting in trouble.

    I find it ironic that a quick google search makes it tricky to find a general directory of CAs and CPAs, though. No wonder people keep coming back here with questions.

  15. My Dad is thinking of leaving me his cottage in his will. What taxes or other costs would I incurr at the time I inherit it? Would it be better for him to tranfer it over to me now?

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