If the sale price of a capital asset exceeds the purchase price, you make a profit. As per CRA rules, you will be required to pay capital gains tax on this profit. However, in case of specific assets, CRA provides a tax exemption of up to $800,000 on the total gains. This exemption is known as LCGE.
Three types of assets are eligible for LCGE. These include:
The main aim behind LCGE is to encourage investment in small businesses, farming and fishing. So instead of so-called safe asset classes, the Canadian government is encouraging people to invest in productive assets.
When you make capital gains, you need to pay tax on 50% of the gained amount. But in case of above-listed assets, you can claim an exemption of up to $800,000 on the total gain (or $400,000 of the taxable amount). This benefit of $800,000 is available for total gains over the entire lifetime, and so you can carry forward the remaining amount.
For example, you sell an eligible capital asset at a gain of $1,000,000 over the original price. Under LCGE, you can straightaway deduct $800,000 from this gain, and so your net gain will be $200,000.
Or in other words, under capital gains rules, you are supposed to pay tax on $500,000 of this amount. However, you can deduct $400,000 from this amount and pay tax only on $100,000.
To qualify for LCGE, the CRA has set out several rules for each of the assets listed above. For example, a small business corporation must be a Canadian-Controlled Private Corporation. Or in the case of farm property, even milk and egg quotas are eligible for LCGE. In the case of fishing property, the property can include land or fishing vessel.
Apart from the property being qualified, there are certain other conditions to claim LCGE. Like, you must be a resident of Canada for the entire tax year. In the case of all the properties listed above either you, your spouse or your common-law partner can be the owner. Also, CNIL (Cumulative Net Investment Losses) reduce the taxable gain. CNIL is the difference between expenses incurred over investments expenses and their income. So for example, if you have a capital gain of $60,000 and a CNIL of $20,000, you can claim an exemption only on $40,000.
LCGE can provide significant tax savings. Importantly, these benefits are spread over the entire lifetime. However, like all tax saving tools, there are conditions attached to LCGE. You need to seek the advice of a qualified tax professional or refer to the CRA website to understand the rules in detail.