If you sell your business, you may have capital gains, and by law, you have to report those gains on your tax return. You normally have to pay tax on most of the gains, but luckily, you may be able to claim deductions on some of the gains. Before you sell, here’s what you need to know.
Setting Up the Sale
When you sell a business, you sell everything for a single price, but the CRA treats the sale of various assets differently. To ensure you get all the possible tax benefits of the sale, you may want to outline the value of each asset in your sales contract. For instance, you may want to specify which portion of the price is for inventory, buildings, or other types of business assets.
Reporting Capital Gains From the Sale of Your Business
You can report the majority of your capital gains on Form T2125 (Statement of Business or Professional Activities). This is the form that you use to report your business income and expenses every year. It also has spots where you can record money you earned from the disposition (sale) of your business property.
For capital gains not covered on that form, you should use Schedule 3 (Capital Gains or Losses) and submit it with your tax return. The form has places where you can record gains and losses from selling small business shares, farm or fishing property, and real estate as well as other types of property.
Paying Tax on Capital Gains
You usually don’t have to pay tax on all of your capital gains. You only have to pay tax on half of your gains. For instance, if you have a total of $100,000 in capital gains, you only have to include $50,000 as taxable income on your tax return. Schedule 3 works you through these calculations. In addition, some capital gains qualify for a deduction, and in those cases, you don’t have to pay income tax on any of the capital gain.
Qualifying for the Capital Gains Deduction
You can claim a capital gains deduction on the sale of qualified farm or fishing property as well as qualified small business corporation shares. Qualified farm or fishing property includes real property, such as land, buildings, tractors, and boats, but it also includes milk and egg quotas and shares in family-farm or fishing corporations owned by you or your spouse.
Qualified small business corporation shares include shares owned by you, your spouse or partner for the last 24 months. The shares must be from a Canadian-controlled private corporation with more than half of its assets used to carry on business in Canada.
Imagine you own a farm and you sell the land for $200,000, the equipment for $50,000, and all of the shares in the farm for $100,000. Because all of those capital gains qualify for the deduction, you don’t have to pay income tax on any of the $350,000 you have earned from your business sale.
That said, it’s important to note that the CRA has limits on the amount of capital gains exemptions you can claim over your lifetime. You also must be a resident to claim these deductions.
Understanding Lifetime Capital Gains Exemptions
As of 2016, the lifetime capital gains exemption for qualified farm and fishing property is $1 million. Because you only report half of the gain as income, that’s the equivalent of a $500,000 deduction. Here’s how that works:
To continue with the above example, imagine you have reported $350,000 in capital gains related to the sale of your farming business. When filling out Schedule 3, you multiple that amount by 50%. The result is $175,000, and you claim a deduction for that amount. For future years, you still have a remaining capital gains deduction amount of $325,000.
The lifetime capital gains exemption limit for small business shares is $824,176, as of 2016. When you cut that in half, it becomes a $412,088 deduction. This is separate from the deduction for capital gains from farming and fishing property.
Selling Business Assets That Don’t Qualify for the Exemption
In most cases, the capital gains reported on Form 2125 don’t qualify for any special exemptions. That is all business profit that you have to pay income tax on.
On top of that, if you sold publicly traded shares or mutual funds, you cannot claim the capital gains deduction on those gains. You also cannot claim the exemption for gains related to the sale of business real estate or depreciable property. In these cases, you end up paying income tax on half the amount of the gains, but if you have capital losses from previous years, you may be able to use those losses to cancel out these gains. You can roll forward losses indefinitely, and if you incur capital losses in the next three years, you can retroactively apply them to these gains.
Selling your business can be paperwork intensive and confusing. To ensure everything is handled correctly and that you don’t face unnecessary taxes, you may want to consult with a business attorney.