Danielle Kubes is a trained journalist and investor who has written about personal finance for the past six years. Her writing has been published in The Globe and Mail, National Post, MoneySense, Vice and RateHub.ca. Danielle writes about investing and personal finance for Wealthsimple. She has a Bachelor of Humanities from Carleton University and a Master of Journalism from Ryerson University.
Capital gains is a type of income you earn when you sell an investment that has appreciated. Capital gains are taxed advantageously to begin with. Only half the amount of the gain is included in your taxable income, where it is taxed at your normal marginal rate. In theory, this encourages Canadians to use their surplus funds to invest in businesses.
What is the lifetime capital gains exemption?
The lifetime capital gains exemptions (LCGE) is helpful for small business owners and their family members, allowig them to avoid paying taxes on capital gains income up to a certain amount when they sell shares in the business, a farm property or a fishing property. It’s not for personal capital gain.
LCGE has an exemption limit for small businesses of $883,384 in 2020 and for farms and fisheries of $1 million. This amount is indexed to inflation.
Normally, half of that return would be taxed. But with LCGE you’re allowed to subtract that amount from your profits.
Let’s say you sell shares in your small business corporation for $1 million. Normally, you’d be charged taxed on $500,000. But if you use the LCGE you’re allowed to deduct $883,384 for taxable profit which leaves just $116,616. Then you divide that $116,616 in half. You’ll be charged tax on $58,308. The savings are immense. To check out how much capital gains tax you would pay in your situation use this free online tax calculator.
Note that the LCGE is cumulative lifetime limit. You can keep using it until you reach the full amount.
Lifetime capital gains exemption eligibility
Eligibility is a little tricky so we suggest you speak to a qualified accountant. But you likely meet the criteria if…
Your small business is incorporated
The majority of your business has been active in Canada for two years before the sale
The shares are owned by you or someone related to you in the two years before the sale
Three kinds of assets and property qualify for the LCGE: small business corporation shares, qualified farms, and qualified fisherers.
Small business corporation shares
These are shares in a small business (not a public or large business) that is mostly owned by Canadians. If you want to transfer the shares of the business to your children, for example, it would benefit you to use the LCGE because otherwise it will be heavily taxed.
Qualified farms and fisheries
You may qualify for the LCGE if you or your spouse own shares or an interest in a family farm or fishing corporation, or if you sell property like land, buildings, or fishing boats. You can also transfer milk and egg quotas or fishing licenses.
How to claim the lifetime capital gains tax exemption
Once you have consulted an accountant that you meet the necessary criteria, simply sell your business shares at a gain and claim the exemption in your next tax return, as you would any other capital gain.
Other ways to reduce capital gains
If, like most individuals, you don’t qualify for the LCGE here are other ways to reduce your tax burden:
Invest in your TFSA or RRSP
The easiest way to reduce your personal capital gains from equities is to hold those stocks in a registered account like a TFSA or RRSP. While you won’t be able to offset a capital loss against a capital gain, you also will never be forced to pay tax if you make money on a sale.
Defer the capital gain
You can defer a capital gain if you plan to to invest the profits in another venture. This strategy is commonly used by real estate investors.
In cases where you sell a property but don’t receive all the money from the buyer you may be able to defer the capital gain for five years until you get full payment.
This may be beneficial because a lump sum payment may trigger the highest marginal tax rate. If you manage to get small payments annually over five years then you’re paying less in tax overall. Of course, it depends on your other income and if you plan to earn more overall in the future. Consult a qualified accountant for this strategy.
To claim this reserve, fill out form T2017 and send it in with your personal tax return.Easy, fast, and even fun. SimpleTax is CRA-certified tax software that you’ll actually want to use. And you only pay what you want, no catch — get started.
Offset capital losses
You can carry capital losses forward indefinitely and use it to offset any gains. For example, if you lost $1,000 on a stock last year, and made $1,000 on a stock this year, you wouldn’t have to pay any tax on the profit.
Loan your spouse money
Let’s say your partner is a stay-at-home parent and earnes no income, and you have an income of $200,000 a year. Any capital gains you report will be taxed at the highest marginal rate. But since your partner earns no other income, they’ll be charged the lowest possible marginal rate.
But, here’s the catch – if you gift him the money to make investments then you’d actually still be on the hook if he sold. So what you have to do to reduce capital gains is “loan” your husband the funds to start an investment portfolio and charge him 1% interest. This way he’ll be solely responsible for paying (low) tax on any returns.
Donate stocks to a charity
You can avoid paying capital gains if you donate your stocks to a charity. The government normally considers any gifted stock a “deemed disposition,” as if you sold it, but that’s not the case when you give to a charity.
Take advantage of the principal residence exemption
Your house—likely your single most expensive asset—is exempt from capital gains.