How do I crystallize my capital gains exemption before selling my business?

Crystallizing is a planning step, not a sale. The owner of qualifying shares realizes a gain on paper, claims the lifetime capital gains deduction against it, and ends up with a higher tax cost on the shares, so a later sale produces a smaller gain. The CRA describes the deduction on line 25400. The mechanism comes from other parts of the Income Tax Act.

How the election works

Under subsection 85(1), a taxpayer who transfers property to a taxable Canadian corporation for consideration that includes shares can elect jointly with the corporation, on CRA form T2057, an agreed amount. That amount is deemed to be the taxpayer’s proceeds and the corporation’s cost, and it feeds into the tax cost of the shares received. Electing above the current cost base realizes a gain. If the shares qualify, the deduction can be claimed against it.

Where it can go wrong

The shares must meet the definition of a qualified small business corporation share in subsection 110.6(1) of the Act, so first check whether your shares qualify. The lifetime limit is indexed, and you may also need form T936, which calculates cumulative net investment loss, when you claim the deduction. Section 84.1 applies when a taxpayer resident in Canada other than a corporation, such as an individual, transfers shares that are capital property of a corporation resident in Canada to another corporation they do not deal with at arm’s length and the first corporation would then be connected with the second. It reduces the paid-up capital of the purchasing corporation’s shares and can deem a dividend where other consideration is received. What that means for later withdrawals is a question for your accountant.

The minimum tax

Realizing a gain to use the deduction can trigger alternative minimum tax, which is computed separately from regular tax. Some of any minimum tax paid may be deductible from regular tax in later years. Ask your accountant for that calculation as well as the regular one.