Q: I would be interested in understanding the $500,000 lifetime capital gains exemption and what it can be used for.
Can I chip away at it by applying annual small investment capital gains?
A: Canada has had different capital gains exemptions over the years. Until 1972, capital gains were completely exempt from tax.
There was a broad $500,000 lifetime capital gains exemption that was introduced in 1985 that applied to any asset. It was subsequently reduced to $100,000 in 1988, Greg. It was wiped out in 1994, but taxpayers were allowed to bump up the cost of capital assets at that time without selling if they filed the appropriate election.
An enhanced lifetime capital gains exemption limit was introduced in 1994 for $500,000, but it only applied to qualified small business corporation (QSBC) shares and qualified farm properties. In 2006, qualified fishing properties became eligible for the exemption. In 2008, it was increased to $750,000 and in 2014, it was set at $800,000 – to be indexed every year thereafter with CPI inflation.
Currently, the capital gains exemption is $835,714 for QSBC shares or $1,000,000 for qualified farm or fishing properties.
Qualified small business corporation shares do not include publicly traded shares, mutual funds or exchange-traded funds (ETFs), so most investors do not own QSBC shares, Greg.
On that basis, you may not be able to qualify for the lifetime capital gains exemption, but there are other ways to qualify for capital gains exemptions that apply to average investors like you.
One opportunity relates to the donation of securities that have appreciated in value. If you donate shares, stock options or other capital property to charity, you can qualify for a capital gains exemption on the capital gain you would otherwise realize on disposition. This exemption was introduced in 2006.
But donating shares just to save capital gains tax is not a good strategy unless you intend to make those donations anyway, Greg. It’s a good strategy for those who make modest or large donations and also have appreciated assets.
The best and broadest capital gains exemption strategy is the Tax-Free Savings Account (TFSA). Introduced in 2009, Canadians could have a cumulative $52,000 of room if they have never contributed and were 18 years or older in 2009. That’s $104,000 per couple and growing by $5,500 each per year, to be increased in $500 increments over time with inflation.
Parents can even consider gifting money to their adult children or just encouraging them to contribute to their own TFSA once they turn 18.
So while you may not be able to take advantage of the current lifetime capital gains exemption, Greg, there are still other opportunities to earn exempt capital gains.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.