62 What is the Lifetime Capital Gains Deduction? How does it impact Taxable Income and what are the basics of the calculation?

The lifetime capital gains exemption (LCGE) is provided by Canada to encourage individuals who are residents of Canada to start small businesses (a great generator of income!)

The LCGE is used to offset capital gains that arise from the disposition of certain types of properties: qualified small business corporation shares (QSBC’s), and qualified farm and fishing properties (QFFP). For this course, we will be focusing on QSBC’s.

To qualify as a QSBC the following criteria must be met:

• The corporation must be a Small Business Corp (SBC) at the time of sale;
  • An SBC is a CCPC where all (or substantially all) of its assets are used to generate Active Business Income in Canada.
• The QSBC’s shares must be owned by either the individual claiming the LCGE or a partnership, spouse, or common-law partner related to the individual during, and 24 months, preceding the determination time.
• The corporation must have been a CCPC for the 24-months prior to the sale;
• More than 50% of the fair value of the company’s assets must have been used principally in the generation of Active Business Income carried on primarily (90% or more) in Canada.

As of 2019, the lifetime capital gains exemption is $866,912 (indexed to inflation).  That means you could eliminate up to $866,912 of capital gains on the sale of QSBC shares.  This potentially provides huge tax savings, so you want to make sure you understand when, how and to whom the LCGE would apply.

The calculation itself is fairly complex and is based on the lesser of the following three items:

• The unused lifetime deduction – The lifetime deduction is 50% of the exemption (currently $866,912) less any amounts you have claimed as a deduction in prior years.
• The annual gains limit – This basically limits the amount of the Lifetime Capital Gains Deduction to the net taxable capital gain in 3(b) in a year.  Note, this is a tricky calculation that looks at ABIL’s and Net Capital Losses, for further details see ITA 110.6(1)
• Cumulative gains limit – This looks at prior year usage of the capital gains deduction and considers the Cumulative Net Investment Loss.  This is another tricky calculation, see ITA 110.6(1) for details.

Here is the process you would follow to apply your Lifetime Capital Gains Deduction:

1. Determine if you are eligible for the lifetime capital gains exemption
2. Calculate the taxable capital gain on the sale of your QSBC
3. Calculate the Capital Gains Deduction (using the ‘lesser of 3’ items listed above)
4. Claim this amount as a Division ‘C’ deductions.

For example:

In 2019, you disposed of qualified small business corporation shares of $1,000,000 that you purchased for $100,000 in 2018. You are eligible for your first-time use of the lifetime capital gains exemption and have access to the full amount. To claim this deduction,

Step 1: Determine if you are a QSBC…we’ll assume that is the case here.

Step 2:  Determine the amount of the taxable capital gain in 3(b).  In this case there is a $450,000 taxable capital gain (50% X ($1M – $100K).

Step 3:  Determine the amount of the Lifetime Capital Gains Deduction.  Will assume that it is 100% available and therefore the Lifetime Capital Gains Deduction is $433,456 ($866,912 X 50%)

Step 4:  Claim your lifetime capital gains deduction of $433,456 as a division ‘c’ deduction to offset your taxable capital gain in S3(b).

Interactive content (Author: Rumabel Mateo, February 2020)

References and resources:

• ITA 80.03(8)
• Article — “The Lifetime Capital Gains Exemption” (Author: TurboTax Canada)
• Article — “What is the capital gains deduction limit?” (Author: Government of Canada)

January 2020