Using a Family Trust to Multiply the Capital Gains Exemption

If you own a successful corporation, you may have heard that a family trust can let a spouse and adult children each use their own capital gains exemption on a sale. The idea is attractive: several exemptions could shelter far more than one.

This article explains in general terms why owners consider the idea, which tests in the Income Tax Act matter, and what the risks are. It does not cover every rule that can apply to trusts, and a structure like this should only be set up with advice from a lawyer and accountant working together.

Why owners think about a trust

The LCGE limit is $1,250,000 for dispositions of qualifying property after June 24, 2024, and the CRA lists $1,275,000 for 2026 dispositions. The statute describes the deduction as something an individual claims. So if a gain on qualifying shares could properly be realized by several individuals, each might use an exemption, which is the idea behind multiplying it.

Whether that is actually possible depends on who really owns the shares, for how long, and in what form. The rules are strict, and a plan that looks fine on a diagram can fail one of the tests.

The share tests every claimant must meet

For shares to qualify, a qualified small business corporation share must at the determination time be a share of a small business corporation owned by the individual, other than a trust that is not a personal trust. A trust that is not a personal trust therefore cannot be the owner for this purpose.

Two tests look back over time:

• Holding period: throughout the 24 months immediately before the determination time, the share must not have been owned by anyone other than the individual or a person or partnership related to the individual.
• 50% test: throughout that 24-month period, more than 50% of the fair market value of the corporation's assets must be attributable to assets used principally in an active business carried on primarily in Canada, or to certain shares or debt of connected corporations.

Any further asset test that applies at the time of sale should be checked against the current wording with your advisers. Also note that because the 50% test looks back 24 months, passive assets such as cash held for a long period can cause trouble, and cleaning up a corporation shortly before a sale may not fix a failure in the earlier period.

Why newly issued shares are a trap

Under s. 110.6(14)(f), shares issued after June 13, 1988 to a particular person or partnership are deemed to have been owned immediately before issue by a person unrelated to that person. That deemed unrelated owner can break the 24-month holding period for newly issued shares, subject to the exceptions listed in that paragraph.

In practice, this means that issuing new shares to a trust or to family members shortly before a sale can mean the holding period test is not met. Whether an exception applies depends on the facts and the exact text, which is why this step needs legal review before it is taken.

Other limits on how much each person can claim

Even if each person qualifies, their own history controls their own exemption. The annual gains limit is reduced by that individual's ABILs for the year, and the cumulative gains limit subtracts that individual's CNIL at the end of the year. How earlier claims affect each person's room depends on their situation, so it is worth confirming with a lawyer or accountant. A family member who has never claimed anything may have more room than you, or less if they have large investment expenses.

Beyond the exemption tests, other tax rules can apply to income and gains that pass through a family trust or to family members, and they can change the result. Those rules are outside this article, so ask your tax adviser to review them for your structure.

Alternatives and what to do next

If your goal is to keep value in the family, there are other routes. A sale of shares to a child resident in Canada can qualify for a 10-year capital gains reserve instead of the usual 5 years. When a Canadian-resident individual sells shares to a corporation they do not deal with at arm's length, a deemed dividend can apply. If the immediate or gradual intergenerational transfer conditions are met, the seller and the purchaser corporation are deemed to deal at arm's length, so the sale can be taxed as a capital gain. Those conditions include control by children aged 18 or older, time limits of 36 months or longer, and a joint election. They are technical, so get advice first.

• Write down who owns the shares today, how long they have owned them, and whether any shares were recently issued.
• Ask your accountant whether the corporation passes the 50% test throughout the last 24 months.
• Find out each family member's past exemption claims, ABILs and CNIL.
• Ask a lawyer whether the proposed trust is a personal trust and whether newly issued shares would break the holding period.
• Have the AMT effect estimated for each person, and do not sign a sale agreement or move shares until the plan has been reviewed.

Frequently asked questions