In a previous article entitled "Lifetime Capitals Gains Exemption", we explained what the lifetime capital gains exemption ("LCGE") was, whom it benefits, and the conditions for its application. To put it briefly, the lifetime capital gains exemption is a tremendous tax-saving advantage tool for business owners. Qualifying business owners can exempt a total amount of $883,384 from the proceeds resulting from the sale of certain property, such as shares in a business. The conditions to qualify for the LCGE can be quite difficult to meet and hard to understand for business owners. The article below will outline tactics that can help unqualifying business owners gain eligibility and optimize exemption benefits.
One of the conditions a business owner must meet is 90% of the company's assets must be used in an active business. However, if a business owner's assets do not meet this threshold, he can attempt to purify them to meet it. In simple terms, purification is how a business owner utilizes his passive assets to earn him active business income. If the owner can successfully do so, he will meet the 90$ threshold.
To do so, there are several methods at his disposal. These include but are not limited to using passive assets to pay down liabilities, purchasing active assets or issuing dividends to shareholders. The goal when purifying assets to recharacterize or eliminate passive assets to ensure that business’ assets meet the 90% threshold.
Crystallization is a tactic used by shareholders to guarantee their eligibility for the LCGE. In involves applying the LCGE to shares when all the necessary tests are met so that when it comes time to sell the shares in question, the conditions required to claim the LCGE no longer matter. In essence, crystallization is used to secure the benefits of the LCGE.
In most cases, this tactic involves triggering a capital gain on the QSBCS via a transaction. In doing so, the shareholder will increase the adjusted cost basis ("ACB") in the property he received at the end of the transaction. The transaction is often controlled to ensure that the capital gains that are intended to be triggered will be equal to the exemption amount that may be claimed. As a result, the property can be sold in the future. The shareholders will be guaranteed tax savings equal to the capital gains exemption.
John is the proud owner of Metacom Inc. shares. Initially, the shares cost him $1 each. Thus, the shares had an ACB of 1$. These shares are currently worth $800,000 and meet the conditions for the LCGE. To tax advantage of the current situation and ensure the tax advantages the LCGE procure him, John decides to crystalize. As a result, he triggers the capital gain and uses the exemption to increase his cost basis to $800,000. By doing so, as long as John's shares remain valued at a minimum of $800,000, there would be no capital gain on the first $800,000 at the time of the future sale of the shares. This is because the sale price would be equal to his cost basis.
Had John not crystalized, he is incurring the risk of claiming the exemption as his shares might not meet the conditions in the future.
This tactic involves the multiplication of the exemption amount across the family unit. By using the LCGE available to family members, a business owner can reduce the overall income tax liability resulting from the sale of a business.