Does a vendor take-back affect the seller’s lifetime capital gains exemption?

A vendor take-back means the seller is paid part of the price later. The lifetime capital gains exemption is a separate question: it concerns which gains can be sheltered, not when the money arrives. The CRA describes the benefit as a capital gains deduction. How the two fit together depends on what was sold and when.

The exemption follows the property sold

Section 110.6(2.1) of the Income Tax Act allows the deduction for an individual (other than a trust) who was resident in Canada throughout the year and who disposed of a share of a corporation, in the year or a preceding taxation year, that was a qualified small business corporation share at the time of disposition; subsection (2) covers qualified farm or fishing property. Both are subject to the limits and exclusions elsewhere in section 110.6, including subsections (4) and (6) to (8). That is a share of a corporation. A sale of assets by the corporation is a different transaction, which our asset sale answer covers.

The share tests are applied at the sale

Whether a share is a qualified small business corporation share is tested at a determination time, and the definition includes a look-back over the preceding 24 months. Section 110.6(2.1) asks whether the share was a qualified small business corporation share at the time of disposition, so those are the tests to check.

Gains brought in from a reserve

If you claim a capital gains reserve on a vendor take-back, part of the gain is reported in later years. The CRA states that a gain brought in from a reserve qualifies for the capital gains deduction only if the original gain was from an eligible property. Its Line 25400 guide adds that, for a reserve relating to a prior-year disposition of qualified small business corporation shares or qualified farm or fishing property, the amount of the deduction you can claim is based on the year the property was disposed of.

Questions to put to your advisor

• Were the shares qualified small business corporation shares when sold, given the 24-month tests?
• Is a reserve being claimed, and for how many years?
• Which year’s deduction rules apply to each later reserve inclusion?
• What happens to the note if the buyer stops paying?