If You Run a Business · 🇨🇦 Canada

Lifetime Capital Gains Exemption (LCGE) on Small Business Shares

Difficulty Hard Applies To All Provinces & Territories Last Updated 2025-01-01

Overview

The Lifetime Capital Gains Exemption (LCGE) is one of the most powerful tax-saving tools available to Canadian small business owners. When you sell shares of a Qualified Small Business Corporation (QSBC), you can claim an exemption of up to $1,250,000 (2024 indexed amount) against the resulting capital gain — sheltering that gain entirely from tax.

At a 50% capital gains inclusion rate and a ~53% top marginal rate, a $1.25M QSBC gain would otherwise generate roughly $330,000 in federal+provincial tax. With the LCGE, that tax is eliminated.

The LCGE is per individual — a business owner with a spouse and adult children who hold shares can potentially multiply the exemption.

Qualifying for the LCGE: QSBC Requirements

The selling shares must meet all three tests at the time of sale:

1. The Small Business Corporation Test (At Time of Sale)

  • The corporation must be a Canadian-Controlled Private Corporation (CCPC)
  • 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 be shares/debt of other QSBCs)

2. The 24-Month Holding Test

  • The shares must not have been owned by anyone other than the individual or a related person in the 24 months prior to the sale

3. The 50% Asset Test (During 24 Months Prior to Sale)

  • Throughout the 24 months before the sale, more than 50% of the corporation’s assets must have been used in an active Canadian business

The Biggest Trap: Excess Assets (Passive Investments)

The most common reason LCGE claims fail or are partially reduced is too much cash or passive investment assets sitting inside the corporation. A company that has accumulated significant retained earnings in a holding account (GICs, investment accounts, excess cash) may fail the 90% active asset test at sale time.

Pre-sale corporate purification strategies are commonly used:

  • Pay out excess cash as dividends or salary before the sale
  • Loan funds from the corporation to the shareholder (must be repaid per ITA s.15)
  • Invest in active business assets to bring the ratio back above 90%

Multiplying the Exemption

Each individual who owns qualifying shares has their own LCGE. Business owners commonly structure ownership to allow family members to participate:

  • Spouse shares: If a spouse holds shares directly, they have their own $1.25M LCGE
  • Family Trust with multiple beneficiaries: A discretionary family trust owning shares can, on a sale, allocate capital gains to multiple adult family member beneficiaries — each using their own LCGE
  • Employee share purchases: Certain employees owning shares may also claim the LCGE

However, the 2018 TOSI (Tax on Split Income) rules significantly curtailed income-splitting with family members who are not actively involved in the business. The TOSI rules apply to capital gains allocated from trusts in some circumstances — careful structuring with a tax lawyer is essential.

Asset Sale vs. Share Sale

Many purchasers prefer to buy assets rather than shares (to avoid inheriting historical liabilities). The LCGE only applies to share sales. Sellers should negotiate strongly for a share sale structure, and buyers may demand a price premium for taking on the liability risk, known as a “Section 22 Election” or other adjustments.

Step-by-Step Planning

  1. Review the corporate structure 12–24 months before a planned sale — purify the balance sheet.
  2. Confirm CCPC status — ensure no non-resident shareholders or public company control.
  3. Establish a family trust (if not already done) well in advance of the sale — ideally 3–5 years before, to allow trust beneficiaries to meet the holding period tests.
  4. Obtain a business valuation to understand the expected gain and how many LCGE claims are needed.
  5. File the LCGE claim on Schedule 3 and Form T657 in the year of sale.

Other LCGE Categories

The LCGE also applies to:

  • Qualified Farm Property (QFP): Same $1.25M exemption for gains on qualifying farm land/quotas
  • Qualified Fishing Property (QFP): Same exemption for qualifying commercial fishing properties

Caveats

  • The cumulative net investment loss (CNIL) account reduces your available LCGE — years of rental losses or investment interest deductions can erode your exemption.
  • Capital gains reserves can spread the LCGE claim over up to 5 years if proceeds are received over time, but care is needed.
  • LCGE can be reduced by prior allowable business investment losses (ABILs).
  • The 2024 federal budget proposed increasing the capital gains inclusion rate to 2/3 for gains over $250,000 — this affects LCGE planning significantly. Consult a tax advisor for current rates.
  • Family trust structures must be carefully maintained to avoid TOSI and attribution rules. This is a complex area — always engage a tax lawyer and accountant with M&A experience.

Frequently Asked Questions

Does the Lifetime Capital Gains Exemption apply automatically when I sell my business, or do I need to file a claim?

You must actively claim it. File Schedule 3 (Capital Gains) and Form T657 (Calculation of Capital Gains Deduction) with your T1 return in the year of sale. The exemption is not automatic — if you don’t file the claim, you will pay full tax on the gain.

What is the 90% active asset test, and how do I know if my corporation passes it?

At the time of sale, at least 90% of the fair market value of the corporation’s total assets must be used principally in an active business carried on primarily in Canada (or be shares or debt of qualifying subsidiaries). The most common failure point is accumulated cash, GICs, or passive investment portfolios sitting inside the corporation. Pre-sale “purification” — paying out excess cash as dividends or salary — is often required to pass this test.

Can a buyer insisting on an asset purchase instead of a share purchase eliminate my ability to claim the LCGE?

Yes. The LCGE only applies to share sales — it has no equivalent for asset sales. If a buyer purchases your business assets rather than your shares, your gain is taxed as a normal capital gain with no LCGE shelter. This is why sellers strongly prefer share sales, and why a price premium is often negotiated when a buyer insists on an asset structure.

Can my adult children claim their own LCGE on shares they receive from a family trust when the business is sold?

Potentially, but the 2018 Tax on Split Income (TOSI) rules significantly restrict this. TOSI applies to capital gains allocated from family trusts to adult family members who are not actively involved in the business — taxing those gains at the highest marginal rate and eliminating the LCGE benefit. Careful structuring with a tax lawyer well before the sale is essential to ensure family members meet the “excluded individual” tests that allow them to claim their own LCGE.

Does the LCGE reset if I haven’t used it yet, or is it a once-in-a-lifetime limit?

The LCGE is a lifetime cumulative limit per individual — currently $1,250,000 (indexed annually). You can use portions of your exemption across multiple qualifying transactions over your lifetime until the total claimed reaches $1,250,000. There is no reset, but any unused portion carries forward indefinitely until you exhaust it or die.