If you sell your business, you may receive capital gains from the sale. Capital gains occur when you make a profit from an investment. By law, you have to report these gains on your annual tax return. Luckily, you may be able to claim deductions, or reductions in the amount of taxable income, on some of the proceeds from the sale of your business. Before you sell, here’s what you need to know.
Setting Up the Sale
When you sell a business, you may 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, consider outlining the value of each asset in your sales contract. For instance, specify which portion of your sale price applies to inventory, buildings, or other types of business assets.
Reporting Capital Gains From the Sale of Your Business
Report the majority of your capital gains on Form T2125 (Statement of Business or Professional Activities). This is the same form you use to report your business income and expenses every year to the CRA. Form T2125 has fields where you can record money you earned from the disposition, or sale, of your business property and assets.
For capital gains not covered on Form T2125, fill out Schedule 3 (Capital Gains or Losses) and submit it with your tax return. Schedule 3 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. Instead, in most cases, you only 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, or your tax software, works you through these calculations. In addition, some capital gains qualify for a deduction.
Qualifying for the Capital Gains Deduction
You may 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. Farm property also includes milk and egg quotas alongside shares in family-farm or fishing corporations you or your spouse own.
Qualified small business corporation shares include shares you, your spouse, or your partner owned for the last 24 months. The shares must be for a Canadian-controlled private corporation that uses more than half of its assets to carry on business in Canada.
For example, say 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 earn from the sale of your business.
That said, the CRA limits the amount of capital gains exemptions you can claim over your lifetime, and you must reside in Canada to claim these capital gains deductions.
Understanding Lifetime Capital Gains Exemptions
As of the 2017 tax year, the lifetime capital gains exemption for qualified farm and fishing property is $1 million. Because you only report half of the gain as income, you can claim up to a $500,000 lifetime deduction.
Here’s how that works:
You report $350,000 in capital gains related to the sale of your farming business. When filling out Schedule 3, you multiply that amount by 50%. The result is $175,000, and you can claim a deduction for that amount. For future years, you still have a remaining capital gains deduction amount of $325,000, or $500,000 minus $175,000.
The lifetime capital gains exemption limit for small business shares is $835,716, as of 2017. When you cut that in half, it becomes a $417,858 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 you report on Form T2125 don’t qualify for any special exemptions. These gains are all business profit for which you must pay income taxes.
On top of that, if you sell 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. However, if you incur capital losses, or if you lose money on an investment from previous years, you may be able to leverage those losses to cancel out these gains. You can roll forward losses indefinitely into future tax years. If you incur capital losses in the next three years, you can also retroactively apply them to capital gains.
Selling your business is a big step. To ensure you handle everything correctly and don’t face unnecessary tax burdens, you may want to consult a business attorney. Keeping accurate records of your income and expenses also helps keep you well prepared for tax time. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.