Lifetime Capital Gains Exemption for Small Business Shares in Canada

If you own shares of a private company and plan to sell, the lifetime capital gains exemption (LCGE) may shelter part or all of the gain from tax. It is one of the most valuable rules in the Income Tax Act for business owners, and it comes with strict conditions.

This article covers the current limit, the tests your shares must meet, how the holding period works, and the reductions that can shrink your claim. Because the tests depend on the company's history, confirm the details with a lawyer or accountant before you sign a sale.

This article covers Canadian federal tax law, which applies in every province.

The current limit

The proposed increase in the capital gains inclusion rate was cancelled, but the LCGE increase was not. Budget 2025 confirmed the increase of the limit to $1.25 million of eligible capital gains for dispositions after June 24, 2024, and indexation resumes in 2026. The January 2025 announcement had also said this increase was not affected by the deferral of the inclusion rate change.

The deduction is half the exemption because only one-half of a capital gain is taxable. Since the increase for 2024 and later is confirmed in Budget 2025, it is sensible to check that the enacting legislation has passed when you are planning a sale.

What property qualifies

The LCGE applies only to qualified small business corporation shares and qualified farm or fishing property. Ordinary investments, such as shares of a public company or a rental property, do not qualify.

Before the exemption comes into play, you first work out the gain. Subtract the property's adjusted cost base and the outlays and expenses of selling from the proceeds of disposition. Only one-half of that gain is a taxable capital gain, and the one-half rate applies to gains realized in 2024, 2025 and 2026. Report the sale in the calendar year it occurs, and file a return even if no tax is owing.

The qualified small business corporation share tests

Section 110.6(1) of the Income Tax Act sets out the tests. In plain terms, the main ones are these:

• Who owns it: the share must be owned by you, your spouse or common-law partner, or a related partnership.
• The 24-month holding rule: the share must not have been owned by anyone other than those persons or related persons throughout the 24 months before the determination time.
• Asset test: while owned, more than 50% of the asset value must be active-business assets or qualifying connected-corporation assets.
• Type of company: the company must be a Canadian-controlled private corporation.

The statute may contain further requirements as well, and the exact wording matters. A company holding large amounts of cash or investments can fail the tests, so a review of the balance sheet over the past two years is a common first step.

Reductions and limits on your claim

Having qualifying shares does not guarantee the full amount. The deduction may be reduced by your cumulative net investment loss, reported on Form T936, and by earlier exemption claims. You must generally be resident in Canada throughout the year to claim it.

If you carried a net capital loss back to a year in which you claimed the deduction, that carryback may reduce a capital gains deduction claimed in that year or later years. Plan carrybacks and exemption claims together.

The calculation is made on Form T657 and the deduction is claimed on line 25400. You still report the sale itself on Schedule 3.

Transfers other than ordinary sales can also trigger a gain. A gift of capital property, other than to a spouse or common-law partner, is treated as a sale at fair market value on the date of the gift, so the giver reports a capital gain or loss. A transfer to a spouse or common-law partner generally occurs at adjusted cost base with no gain or loss, and the transferor can elect out. On death, the deceased is considered to have sold capital property, though spousal transfers and certain farm transfers to a child can be treated differently.

If you sell to a relative for less than fair market value, your proceeds are deemed to be fair market value, but the buyer's cost remains the lower price paid, so the same gain can be taxed twice. How the exemption applies in any of these cases depends on your facts, so it is worth confirming with a lawyer or accountant.

What to do next

• Gather the share register, articles and records showing who has owned the shares for the last 24 months.
• Ask your accountant to review the company's assets against the 50% active-business test.
• Find out whether you have earlier exemption claims or an investment loss that reduces your room.
• Check that you will be resident in Canada for the year of sale.
• Get advice before signing, because restructuring to fix a failed test usually takes time.

Frequently asked questions