Lifetime Capital Gains Exemption

Michael Bronstine

I have been asked by many readers of our newsletter to explain LCGE rules.

The LCGE is the amount of appreciation or gain a qualifying investment can have and still be exempt from taxation on the disposition of the asset. A qualifying investment for the LCGE purposes are the shares of a qualifying small business corporation. For an asset to qualify as a small business, it must meet three tests at the time of disposition:

1. Small Business Corporation (SBC) test: All or substantially all the business’ assets must be employed in an active business carrying out business primarily in Canada for the 24 consecutive months before disposition. “All or substantially all” of the assets are considered to be 90% of the company’s fair market value (FMV) and “primarily in Canada” generally means at least 50% of the business activity is in Canada.
2. Holding Period test: The shares must not have been owned by anyone other than the individual or a person related to the individual throughout the 24 months preceding the disposition.
3. Basic Asset test: Throughout the 24 months prior to disposition, the business must qualify as Canadian-Controlled Private Corp (CCPC) and more than 50% of the company’s assets had to have been used in an active business carried on primarily in Canada.

It is key to note here that the LCGE can only be claimed by individuals, trusts, or partnerships. Under certain circumstances, if the qualifying small business shares are held by a family trust, or a partnership, all the beneficiaries of the trust, or partners, may be able to take advantage of their own LCGE. Simply put, this means the gain is multiplied by the number of beneficiaries of the trust or number of partners in a partnership.

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The next critical issue then becomes how much the LCGE. For 2020, the exemption is $883,384 and will be adjusted for inflation for 2021 and into the foreseeable future. This number applies to qualifying Small Business Corporation (SBC) shares, but there are two more groups or entities that can qualify for the exemption. The first is a Qualified Fishing Property and the second is a Qualified Farm Property. In both cases, the exemption is increased to $1 million.

If we look at the following example, whereby Mary is the sole owner of a company that qualifies as an SBC. The ACB on her shares is $100, and she sells her shares for $1,000,100. Without the LCGE, Mary is faced with a total capital gain of $1 million. At a 50% inclusion rate, and a 50% MTR, she will pay $250,000 in tax. Now with the LCGE, there is the same $1-million total capital gain, but it is reduced by the LCGE ($883,834) for a gain of $116,166. Again, at a 50% inclusion rate and a 50% MTR, her taxes owing will be $29,042, for a total tax savings of $220,959.

As a side note, with governments desperate for additional revenue, there is much discussion about changing the capital gains inclusion rate from the current 50% to 67%, or even as high as 75%.

There is an additional way that an individual can take advantage of the LCGE during their lifetime without disposing of the shares, which is the Estate Freeze (crystallization). This might allow the client to take advantage of the current inclusion rate. This is where a shareholder “exchanges” existing common shares in a QSBC for fixed value preferred shares. New common shares are issued to new/existing shareholders, such that future growth in the company accrues to these newly issued commons. The LCGE can now be applied against the value of the preferred shares as they are redeemed. The first $883,834 of preferred shares that are redeemed will be applied against the LCGE resulting in no tax payable.

As mentioned above, one additional way of taking advantage of the LCGE is to have the gains on a QSBC accrue inside a Family Trust. If the shares of a QSBC are held inside a Family Trust each beneficiary of the Trust may be able to utilize his or her entire LCGE and therefore multiplying it from just one individual to all beneficiaries of the Trust. Using a Family Trust to spread the LCGE over multiple beneficiaries is a complex concept with many aspects that are far beyond the scope of this article. Just let it be known it is possible to have the LCGE of one individual inside a trust and have it multiplied by the number of beneficiaries. For example, if I have a Family Trust with five beneficiaries and a QSBC with an ACB of $1, and FMV of $5 million, the beneficiaries of the Trust could, in theory, shelter over $4.4 million ($883,834 x 5) of otherwise taxable capital gains.