Lifetime Capital Gains Exemption
Lifetime Capital Gains Exemption in Canada: How to Qualify Through Your Small Business Shares
For many entrepreneurs, the eventual sale of their business is both a major personal milestone and a financial windfall. However, selling a business also creates a tax liability—one that can significantly erode the wealth built over decades.
Enter the Lifetime Capital Gains Exemption (LCGE), a powerful tax benefit that can exempt up to $1.25 million of capital gains from taxation (as of 2025) on the sale of Qualified Small Business Corporation Shares (QSBCS). For small business owners, this exemption can translate into over $300,000 in tax savings—but only if you plan properly.
In this article, we dive deep into how the LCGE works, the specific QSBCS qualification criteria, planning opportunities, and real-world examples that show how to maximize this exemption when exiting your business.
What Is the Lifetime Capital Gains Exemption (LCGE)?
The LCGE is a federal tax benefit that allows Canadian residents to exclude a certain amount of capital gains from taxation when they sell eligible property—specifically, QSBC shares, and (although not covered here) qualified farm and fishing property.
As of June 25, 2024, the LCGE limit is set at $1.25 million and will be indexed to inflation starting in 2026. This lifetime cap means that once you’ve claimed the full exemption, no additional gains are eligible unless the threshold is increased in the future.
Why It Matters: The Tax Mechanics
Capital gains in Canada are taxed at 50% inclusion, meaning only half of your capital gain is included in your taxable income. If you sell your business and claim the LCGE:
You shelter $1.25 million of gross capital gains, which equates to $625,000 in taxable capital gains.
This means that if your marginal tax rate is 48%, the LCGE could save you up to $300,000 in taxes.
The actual benefit depends on your province of residence, income level, and prior use of the exemption.
Who Can Claim the LCGE?
To claim the LCGE:
You must be a Canadian resident at the time of the sale.
You must dispose of QSBC shares that meet all conditions.
You must not have fully used up your lifetime exemption in the past.
You must file the correct CRA forms (T657 and T936).
This blog focuses exclusively on the sale of Qualified Small Business Corporation Shares, the most common route for entrepreneurs to use the LCGE.
Defining a Qualified Small Business Corporation (QSBC)
Not all private corporations qualify for the LCGE. To be eligible, a company’s shares must meet three specific tests under the Income Tax Act (section 110.6):
1. SBC Test (at the Time of Sale)
At the time of sale, the corporation must be a Small Business Corporation (SBC), which means:
The company is a Canadian-Controlled Private Corporation (CCPC).
At least 90% of the fair market value of assets is used in an active business carried on primarily in Canada.
What Counts as “Active Business”?
Active business assets include:
Inventory and supplies
Equipment and machinery used in day-to-day operations
Office furniture and technology
Accounts receivable
Cash or working capital used within the business
Passive or ineligible assets include:
Excess cash not needed for business operations
Marketable securities or investment portfolios
Rental properties (unless core to business)
Loans to non-affiliated parties
Example:
A consulting firm owns $900,000 in computer systems, receivables, and office equipment—and $100,000 in excess cash. Since 90% of its assets are used in the active business, it meets the test.
Counterexample:
A construction company with $600,000 in equipment and $400,000 in a long-term investment portfolio would fail the test—only 60% of its assets are used in active operations.
2. Holding Period Test (24 Months Rule)
You—or a related person (spouse, child, parent, or trust)—must have held the shares for at least 24 months before the sale.
The shares must not have changed hands or been reacquired within that time.
Example:
If you incorporated a business in January 2023 and plan to sell in February 2025, you meet the 24-month rule.
3. Asset Use Test (Over the 24 Months)
For at least 50% of the time during the 24-month holding period, more than 50% of the fair market value of the corporation’s assets must have been used in an active Canadian business.
This test looks at the history of the business, not just its status at the sale date.
Example:
If your company spent most of the last 2 years developing software and hiring staff but held excess cash for only 3 months, you’re likely compliant.
Pitfall:
Companies holding cash from a financing round or recent property sale might need to prove that the cash was temporarily idle and intended for reinvestment.
Purification: Getting Your Shares LCGE-Ready
If your corporation doesn’t meet the asset-use thresholds, purification strategies may help.
Common purification actions:
Paying bonuses or dividends to reduce retained earnings
Transferring investment assets to a holding company via a tax-free rollover (s. 85)
Acquiring active assets, like equipment or inventory, to balance the asset mix
Repaying loans or advances that sit idle on the balance sheet
Timing is critical. These steps should be completed well before the 24-month threshold to reset the clock and qualify the shares.
Claiming the Exemption: Required Tax Forms
To use the LCGE, you must complete the following forms with your T1 Personal Tax Return:
T657 – Calculation of Capital Gains Deduction
T936 – Summary of Cumulative Net Investment Loss (CNIL)
If you’ve ever claimed investment losses or had prior LCGE usage, your deduction limit may be reduced.
Important: CRA may ask for supporting documentation like corporate financial statements, tax returns, and proof of asset usage. It’s best to prepare a detailed analysis in advance of any sale.
Multiplying the Exemption with Family Trusts
Each Canadian individual has their own LCGE limit. That means families can potentially multiply access to the exemption using trusts or family ownership structures.
Example:
A family trust holds shares of an active business. At sale, the $2.5 million capital gain is allocated equally to two adult children and two parents. If each has their full LCGE limit, the entire gain could be tax-free.
However, this is not automatic:
Each beneficiary must be eligible to claim the LCGE
Attribution rules and TOSI (Tax on Split Income) must be considered
Trusts must be properly structured and managed
Tip: Always consult with a tax advisor before implementing trust strategies.
CNIL & ABIL: How They Reduce Your LCGE
CNIL: Cumulative Net Investment Loss
If your past investment expenses (e.g., interest on loans to buy investments) exceed your investment income, you accumulate a CNIL balance. This directly reduces your available LCGE.
ABIL: Allowable Business Investment Loss
If you’ve claimed an ABIL in the past (e.g., after a failed business venture), it may also reduce your LCGE room.
Before selling your business, have your accountant confirm your CNIL and ABIL history.
Case Study: Selling a Tech Company
Natalie built a web design company over 8 years. She owns 100% of the shares, which she acquired in 2017. The company has no investment assets and holds $50,000 in excess cash. In 2025, she sells her business for $1.8 million, resulting in a $1.7 million capital gain.
Without LCGE:
Taxable capital gain: 50% of $1.7M = $850,000
Tax (approx. at 48% rate): $408,000
With LCGE:
Exempt portion: $1.25M
Taxable portion: $1.7M – $1.25M = $450,000 × 50% = $225,000
Tax due: ~$108,000
Savings: ~$300,000
Result: Natalie keeps significantly more of her exit proceeds.
What This Means for LCGE:
The LCGE will still apply at the 50% inclusion rate, regardless of your total gains.
You still shelter $1.25 million of gross gains, translating to $625,000 of taxable capital gains.
This increases the relative value of the LCGE compared to post-threshold gains.
Final Thoughts
The Lifetime Capital Gains Exemption is not just a tax benefit—it’s a reward for risk-taking and entrepreneurial effort. However, the rules are strict, and failure to qualify could result in a six-figure tax bill.
If you’re thinking of selling your business, gifting shares, or reorganizing your company, start planning early. Many problems—such as passive asset issues or short holding periods—can be solved with time, but not at the last minute.
At ModernAxis, we work closely with business owners to:
Confirm eligibility for the LCGE
Reorganize ownership or corporate structure to qualify
Plan trust and family strategies to multiply the exemption
Assist with CRA compliance and documentation
Looking to sell or restructure your business? We can help you protect your gains and transition successfully.