Capital Gains Reserve When You Are Paid Over Time: Ontario

Many business sales are not paid in one lump sum. The buyer may pay a deposit on closing and the rest over several years, or you may take back a promissory note. If the whole gain is taxed in the year of sale, you could owe tax on money you have not yet received.

The capital gains reserve is the rule that eases this problem. This article explains in plain terms how it works, how the five-year spread is calculated, and the situations where it is limited or not available. Your own numbers will depend on your facts, so confirm the details with a lawyer or accountant.

What the capital gains reserve does

Normally, you report a capital gain in the year you sell. Only one-half of a capital gain is taxable. When part of the sale price is payable after the end of the year, you can claim a reserve under Income Tax Act s. 40(1)(a)(iii).

A reserve holds back part of the gain from that year's income and pushes it into later years. In practice, this lines up your tax with the cash you actually receive, and it can keep income spread across several years instead of piling it into one.

The gain itself is the proceeds less your adjusted cost base and the outlays and expenses of selling, such as commissions, legal fees and advertising.

How the five-year spread works

The reserve for a year is the lesser of two amounts: a reasonable amount for the unpaid proceeds, and 1/5 of the gain multiplied by (4 minus the number of preceding years ending after the sale).

The result is that at least 1/5 of the gain is taxed each year, and the whole gain is taxed within five years. The CRA describes this as a reserve period of generally up to four years, so the gain is included in income over five years in total.

If the unpaid amount is smaller, the reasonable-amount limit may reduce the reserve further, and the gain would be taxed sooner.

Longer periods for some family and intergenerational sales

A longer period applies in some cases. When qualified small business corporation shares (or family farm or fishing property) are sold to your child who is resident in Canada, the reserve fraction becomes 1/10 and 9, which spreads the gain over 10 years.

A 10-year reserve also applies to shares sold to a corporation where the s. 84.1(2.31) or (2.32) intergenerational conditions are met, and to shares sold under a qualifying business transfer.

These rules are detailed and come with conditions, so check the full requirements for your situation before relying on them.

When no reserve is allowed

• You were not resident in Canada, or were tax-exempt, at the end of the year or at any time in the following year.
• The buyer is a corporation you control directly or indirectly.
• The buyer is a partnership in which you are a majority-interest partner immediately after the sale.

Separately, if you sell shares to a corporation you do not deal with at arm's length and the corporations become connected, non-share consideration above the greater of paid-up capital and ACB can be deemed a dividend rather than a capital gain, and the capital gains exemption cannot shelter that amount. How this applies depends on your situation, so it is worth getting advice before structuring a sale to a related company.

Reserve and the lifetime capital gains exemption

If you are selling qualified small business corporation shares, you may be able to claim the lifetime capital gains exemption. For dispositions after June 24, 2024 and for 2025, the limit is $1,250,000 of gains, a maximum deduction of $625,000. The $625,000 amount is indexed to inflation for taxation years that begin after 2025, so the limit for a later year can differ from the 2025 figure and is worth confirming before you rely on it. Any amount can be claimed in a year, up to the maximum allowable.

Because you can choose how much to claim in a year, how you combine the exemption with a reserve is worth planning. Also note that a large gain sheltered by the exemption can trigger alternative minimum tax, calculated on Form T691. Deferred gains do not qualify for the deduction, so the interaction between a reserve and the exemption is a point to review with a tax professional.

What to do next

• Get the sale agreement in writing, with the payment schedule and any security for the unpaid balance.
• Calculate your gain using your adjusted cost base and selling costs.
• Check whether you or the buyer fall into an excluded situation, such as a controlled corporation or partnership.
• Ask whether a 10-year period could apply if you are selling to a child or in an intergenerational transfer.
• Plan to claim the reserve on Form T2017, Summary of Reserves on Dispositions of Capital Property.
• Have a lawyer or accountant review the structure before you sign.

Frequently asked questions