As of March 19, 2007, the capital gains exemption has been increased to $750,000 from its previous $500,000 limit. This means that if you haven’t already taken advantage of the tax preferred treatment of capital gains on qualified small business shares, you should do so while the getting’s good. If you have already maxed out your $500,000, you have an additional quarter million to play with.
Continuing the series of “quick facts” posts (see prior ones about the capital gains exemption and the new financial instruments standards), today is all about the principal residence exemption in Canada.
- Any residence may be designated a principal residence as long as you “ordinarily inhabit” the home. Ordinary inhabitation includes seasonal living such as your cottage and mobile homes such as a trailer or even a boat, as long as you lived on it!
- The designation of principal residence occurs in the year you dispose of it, and of course only one residence can be designated as principal for each specific year of ownership.
- The capital gain, if it cannot be entirely exempted, is prorated for the number of years you owned it and have designated it your principal residence over the total number of years you owned it.
- Deciding which residence to designate as principal depends on the capital gains on all owned residences on a per year basis, and then allocating each year in the optimal way to minimize the recognized gain.
- Starting in 1982, married couples who own more than one residence can only designate one family principal residence, called the “family unit” in the Tax Act.
- You can even designate foreign-owned homes as principal, but could incur foreign taxes upon sale. Naturally, the exemption applies only to your Canadian tax liability!
- If you rent out a home and decide to begin living in it, this “change in use” results in a deemed disposition and could result in a gain. An election exists to defer recognizing this gain until you ultimately sell the home.
- Conversely, if you live in a home and then begin renting it, you can still designate it as your principal residence for a number of years beyond that point. The exact number of years will depend on your specific details.
So to sum up the key points: Only one principal residence each year for the family unit, optimal tax planning requires estimating or calculating the gain per year for each residence owned, and a change in use has special rules that could result in a gain.
This is a very basic look at a complex section of the Tax Act. As with any general tax discussion, your personal situation is unique and requires the expertise of a Chartered Accountant. If you need a CA, please contact me and I will be happy to help you find one in your area!
Generally when a disposition of capital property occurs, a gain or loss is recognized. Occasionally the disposition results in no real change to the economic interest of the property, like when an individual transfers property to a corporation they own. A rollover provides a way to defer the gain or loss.
Section 85 of the Income Tax Act is where the magic happens. One caveat: The transferor must take back shares in the tranferee corporation in consideration, at the fair market value of the assets transferred. The adjusted cost base of the shares will equal the ACB of the assets. Now if the shares are sold to an unrelated third party (an “arm’s length transaction”) they will fetch the FMV and the gain will be realized. Until that happens though, the gain and tax is deferred.
This works even if the asset being transferred is shares in an operating company. The beauty of Section 85 is it is an election – the transferor can decide and elect the cost of the asset being transferred anywhere between the ACB and FMV. For example, shares with an ACB (or “tax value”) of $100 and FMV of $150 can be transferred at $125, to elect to recognize a gain of $25.
This is how the capital gains exemption is “crystallized”. You can transfer shares of an operating company into a holding company and elect to recognize a $500,000 gain, to use the CGE. The tax value of the shares is bumped up, you’ve utilized the tax advantage of the exemption, and you can go forward as normal, since you received back shares in the holding company worth the new value (the original cost of the operating company shares plus the $500,000 elected gain) in exchange.
As you can imagine this allows some flexibility when it comes to general tax or estate planning. For example, you could offset a capital loss that is expiring by recognizing the equal amount of gain. Or you could take back preferred shares in the holding company from the paragraph above after crystallizing the exemption, and have your children subscribe to common shares, so that future growth of the operating company accrues to the children.
The following conditions are required to be met for the rollover to apply:
- the transferee must be a taxable Canadian corporation
- consideration received must include shares in the corporation or a fraction of a share
- the property transferred can be depreciable or non-depreciable capital property, a resource property or inventory
- a joint election by both parties must be filed
This is just a summary of the very basics of this complex section of the Act. As with any general tax discussion, your personal situation is unique and requires the expertise of a Chartered Accountant. If you need a CA, please contact me and I can provide a referral.
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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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!
The Alternative Minimum Tax is getting a lot of coverage in the US since changes made by Reagan in the 80s are causing it to affect 80% of “families with an adjusted gross income of $75,000 to $100,000,” in other words, a lot of frickin’ families.
When the tax was first introduced in 1969, it was intended to catch only the wealthiest members of American society who were paying little to no tax thanks to various deductions, loopholes and shelters.
But in 1986, … the law was subtly changed to aim at a wholly different set of deductions, the ones that everyone gets, like the personal exemption, state and local taxes, the standard deduction, certain expenses like union dues and even some medical costs for the seriously ill. At the same time it removed and revised some of the exotic investment deductions.
We have AMT in Canada, but since I’m not reading stories in our media about this situation I’m assuming it isn’t a problem. I suppose the fact that we weren’t taught anything about it in any of the three tax courses I took in school supports the assumption that this doesn’t affect nearly as many Canadians.
If I had to guess, it’s because we missed the 1986 adjustments that occurred south of the border.