Lifetime Capital Gains Exemption Planning

The exemption

Subsection 110.6(2.1) of the Income Tax Act provides an individual with a lifetime capital gains exemption on the disposition of qualifying small-business-corporation (QSBC) shares. The 2024 exemption is $1,016,836 of capital gain (indexed annually). At a 50% inclusion rate, that's $508,418 of taxable capital gain — sheltered from federal and provincial tax.

For owners eligible to claim the exemption, the cash value is substantial. At top Ontario marginal rates of roughly 27% on capital gains, the LCGE saves about $137,000 in tax per claimant. Multiplied across a family of four through a properly-structured trust, that's over $500,000 of tax savings — for a business sale at roughly $4M of gain.

QSBC qualification — three tests

To qualify as a QSBC share at the moment of sale, three tests must be met:

• The 90% test: At the time of disposition, 90% or more of the fair market value of the corporation's assets must be used principally in an active business carried on primarily in Canada (or in shares/debt of related corporations that satisfy this test).
• The 50% test: Throughout the 24 months immediately preceding the disposition, more than 50% of the corporation's assets (by FMV) must have been used in such an active business.
• The 24-month holding test: The shares must have been owned throughout the 24 months immediately before the disposition by the individual or a person related to them (with certain look-through rules for shares received in tax-deferred reorganizations).

Purification — getting to 90%

The most common reason an otherwise-qualifying corporation fails the QSBC test is that it has accumulated passive investments — excess cash, marketable securities, rental real estate — that push the active-asset percentage below 90%. "Purification" transactions move the non-qualifying assets out before the sale, restoring the 90% threshold.

Common purification moves:

• Pay out excess cash as a dividend to the shareholder (or to a holdco, with safe-income or capital-dividend planning).
• Transfer passive investments to a separate holding company that's not part of the sale.
• Restructure the corporation so passive assets sit in a subsidiary that's spun out before sale.

Purification has to be planned well before sale — the 24-month test means assets removed too late don't help. Most planning windows are 24+ months before the anticipated sale.

Crystallization

If QSBC status is at risk and a sale may not happen for years, the owner can "crystallize" the available exemption now by triggering a paper disposition (typically a Section 85 rollover at FMV) on shares that currently qualify. The crystallization locks in the exemption claim against the current accrued gain, even if the corporation later loses QSBC status or the gain at eventual sale doesn't otherwise qualify.

Multiplying across the family

If the growth shares of the corporation are held by a family discretionary trust with several beneficiaries (spouse, children, grandchildren), the trust can allocate the capital gain on sale to multiple beneficiaries — each of whom claims their own LCGE on their share of the allocated gain. The trust must be structured properly: the beneficiaries must be valid claimants, the gain must be allocated in the year of sale, and the tax-on-split-income rules (TOSI) must not catch the allocation.

AMT

Claiming the LCGE adds preference items to the alternative minimum tax (AMT) calculation. Most LCGE claims trigger some AMT in the year of claim, which is recoverable as a carryforward against regular tax in the seven subsequent years. The 2024 federal budget materially increased AMT rates and broadened the preference base, making the AMT cost of an LCGE claim more substantial than it was historically.

How we work the file

Most LCGE planning files run on a multi-year horizon. Year one: structural review and purification design. Years two and three: implementation, monitoring, possible trust settlement for multiplication. At sale: claim coordination, gain allocation, AMT modelling, post-sale Section 84(2) wind-up planning. Fixed fees are typical for each phase.