In this newsletter, we will discuss an area that would be of interest to an individual who has a small business, a farm or a fishing property, and who would like to sell or transfer the property. In particular, we will discuss the $750,000 Lifetime Capital Gains Exemption (LCGE) and the $375,000 Lifetime Capital Gains Deduction (LCGD)
Both the $750,000 Lifetime Capital Gains Exemption (LCGE) and the $375,000 Lifetime Capital Gains Deduction (LCGD), which are available to individuals who are resident in Canada, are based on qualifying property.
Qualifying Property for the Small Business Corporation (QSBC) Exemption includes:
- Canadian Controlled Private Corporation (CCPC) shares that also qualify as Qualified Small Business Corporation (QSBC) shares
- Qualified Farm and Fishing Property (QFFP)
How to qualify for the LCGE and LCGD for small businesses
Generally speaking, the Canada Revenue Agency (CRA) uses the following test to qualify small businesses for the $750,000 exemption:
- The shares must be of a Canadian Controlled Private Corporation (CCPC).
- At least ninety per cent of the corporate assets, on a Fair Market Value (FMV) basis, must be used in an active business carried on primarily in Canada at the time of the sale of the Qualifying Small Business (QSB).
- At least fifty per cent of the corporate assets must be used in an active business in Canada for the two-year period prior to the sale.
- Shares of the corporation must be owned only by the taxpayer or a relative (e.g., spouse) for the two-year period prior to the sale.
Qualifying Property for the Farm or Fishing Property (QFFP) exemption includes:
- Real property used for a farming/fishing or a fishing vessel
- Shares of a family farm/fishing corporation or a partnership interest
- Eligible capital property (such as quotas)
How to qualify for the LCGE and LCGD for farming or fishing properties
Generally speaking, the Canada Revenue Agency (CRA) uses the following test to qualify a farm or fishing property for the $750,000 LCGE:
- The property is used in farming or fishing by an individual, spouse or any of their children or parents.
- The property is owned by an individual, spouse or partnership for at least two years prior to the date of sale.
- At least ninety per cent of the farm/fishing property (on a FMV basis) is used to carry on a business of farming or fishing in Canada at the time of sale.
- At least fifty per cent of the farm or fishing property must be used in an active business in Canada for at least two years prior to the date of sale.
The impact of Cumulative Net Investment Losses (CNIL) on the Lifetime Capital Gains Exemption (LCGE):
Under CRA rules, if an individual’s claims investment expenses are greater than their investment income, it creates a net investment loss. The CRA refers to this ongoing balance as “Cumulative Net Investment Losses.” CNIL restricts the Lifetime Capital Gains Exemption (LCGE) when qualifying assets (QSBC or QFFP) are sold.
Investment expenses include interest expense, tax shelter losses (e.g., rental losses), and limited partnership losses.
Investment income includes interest, dividends, rental income, recapture of CCA and annuity income.
CNIL restricts the use of the Long Term Capital Gains Deduction when qualifying assets are sold.
Example of the impact of CNIL on the LCGD:
- In year one, Mr Shed borrows $100,000 to invest in QSBC shares.
- He incurs interest expenses of $10,000 in year one, and two with no offsetting income ($20,000 CNIL).
- In year three, he sells the QSBC shares for $190,000 and expects to use the LCGD to the extent his cumulative investment expenses from all property exceed his investment income.
- Mr. Shed’s capital gain is $90,000: $190,000 FMV - $100,000 ACB
- There is a $45,000 taxable capital gain ($90,000 X 0.50). Without the CNIL balance, Mr. Shed would apply $45,000 of his LCGD towards the $45,000 taxable capital gains and pay no capital gains tax. However, due to the $20,000 CNIL balance, Mr. Shed will be fully taxed on the first $20,000 of the $45,000 taxable capital gain. This will bring his CNIL balance to zero.
- Mr. Shed is allowed to use only $25,000 of his LCGD ($45,000 LCGD - $20,000 CNIL).
- Mr Shed’s LCGD balance after this transaction will be $350,000 ($375,000 - $25,000)
- Mr. Shed’s LCGE balance after this transaction will be $700,000 ($750,000 - $50,000).
See how you do in answering the following two questions relating to the above topic? Detailed answers to these questions will be in the October CFP Study Tip e-newsletter.
1) Abler owns a farm that qualifies for the lifetime capital gains exemption. Abler purchased the farm in 1995 for $600,000. Instead of giving the farm to his adult children, he sells it to them for cash at its fair market value in 2010. The farm has a fair market value of $1,500,000. Abler has never used any of his LCGE/ LCGD. What is the tax payable by Abler in the year of sale assuming a 42% marginal tax rate?
2) Donald Trumpet has not used up any of his LCGE/LCGD in the past but has claimed a total of $30,000 in net investment expenses since 2006. His CNIL balance was $30,000 when he sold shares of a QSBC in 2010. The 10,000 shares originally cost him $12.00 ACB each. The sale price for his 10,000 shares was $90.00 FMV each. What amount of his LCGD could Donald use towards reducing his taxable capital gain?
Ron Foran, CFP, CFA, CLU, FCSI
President, Foran Financial Institute
Ron Foran is the founder of Foran Financial Institute. He has lectured extensively around the world over 24 years on investments and financial planning. Ron has a passion for teaching, training and assisting students to pass exams, and is the primary instructor for Foran securities and investment management seminars. If you want to learn more about Ron or Foran Financial Institute, please go to www.foranfinancial.com.