In my experience with financial planning, it seems one of the most misunderstood topics is that of capital gains and losses, in particular where the Lifetime Capital Gains Exemptions (LCGE) fits into this conversation.
I often hear varying interpretations of the above from clients, mostly intertwining one with the other. I hear along the lines of “when I sell my cottage I can claim the LCGE” or a variety of other misinterpreted statements.
Let’s start with capital gains and losses. Capital Property is defined by Canada Revenue Agency (CRA) as “depreciable property, and any property which, if sold, would result in a capital gain or a capital loss. You usually buy it for investment purposes or to earn income.” Capital property can include securities, such as stocks, bonds etc and real estate. A capital gain is basically defined as selling capital property for more than what you initially paid for it, less any expenses associated with its sale. A capital loss is selling capital property for less than you initially paid for it. The advantage with regards to capital gains is that only half (50%) of a capital gain is taxed at your marginal tax rate. This preferential taxation is advantageous for investors compared to say interest income, which is taxed 100% at your marginal tax rate. Capital gains can also be offset with capital losses from other investments, but not against regular income. Capital losses can be carried forward indefinitely and backwards for three proceeding years allowing to be applied not only currently, but to past and future capital gains. Your primary residence is exempt from capital gains, making owing your home a valuable and tax efficient investment.
Now let’s chat about the Lifetime Capital Gains Exemption (LCGE). The LCGE is available to shelter realized capital gains on the share sale of a Qualified Small Business Corporation (QSBC) or a qualified farm or fishing property. The general criteria of a QSBC is the shares must be those of a Canadian controlled private corporation (CCPC), the fair market value of the assets in the corporation is primarily used in an active business carried on primarily in Canada and 24 months prior to the disposition the shares were not owned by anyone other yourself, a person or partnership related to you. The 2019 LCGE is $866,912 (and adjusted for inflation annually.) The LCGE for qualified farm and fishing properties is $1,000,000. Let’s say you were to dispose of your shares of a QSBC and utilize your entire LCGE, this could amount in over $200,000 of potential tax savings, that is significant! Aside from the sale of your business, you can also take advantage of the LCGE if you implement and estate freeze, transfer the shares of your business to other family members, if your corporation is taken over way of a share purchase or merger and finally, on your death.
All this being said, a family cottage owned in your personal name does not qualify for the LCGE. Always know your cost base of any capital property, capital gain (or loss) = proceeds of disposition, less adjusted cost base, less fees incurred to sell the property. As always, if you have any questions feel free to contact us.
Keep in mind there are always nuances and complexities to the above, always consult your tax advisor to see how the above applies to your personal circumstances.