Lifetime Capital Gains Exemption: Miss the 90% Test by a Dollar and It Costs $303,240
The $1,275,000 lifetime capital gains exemption is yours for life. Whether a particular block of shares can draw on it is a different question, settled by two asset tests measured over two different windows, an ownership test, and a running total most business owners have never filed a form for. One of the asset tests is taken on a single day, the day of the sale, and it is a cliff: 90% or nothing. In the worked case below, an Ontario resident with $60,000 of other income and a gain of exactly $1,275,000, the wrong side of that line costs $303,239.76.
Timing is the other half. The sale-date test can be handled in the week before closing. The 24-month tests cannot be handled at all once you are inside them.
The 2026 Limit Is $1,275,000 and the Deduction Is Half of It
The headline figure is a gain, not a deduction. Only half a capital gain is taxable under paragraph 38(a) of the Income Tax Act, so what goes on the 2026 return is $637,500, claimed on line 25400, as the 2025 Form T657 sets out.
The limit moved this year. It was $1,250,000 of gain and $625,000 of deduction in 2025, and indexation resumed in 2026 at CRA’s factor of 2.0%: $1,250,000 multiplied by 1.020 is $1,275,000, the arithmetic on CRA’s page on the indexation adjustment for personal income tax and benefit amounts. The Act still prints the unindexed figure. Paragraph 110.6(2)(a) starts from $625,000 and subtracts the amounts A, B, C and D, the individual’s deductions in earlier years, before multiplying by E. The formula tracks the person and what they have already claimed, not any block of shares.
One pot, not one per type of property: subsection 110.6(4) caps the total deducted under the whole section for the year, so qualified farm or fishing property draws on the same $1,275,000 as shares. The claimant must also have been resident in Canada throughout the year, with relief in subsection 110.6(5) for a part-year resident who was resident throughout the preceding or following year.
Three Conditions Decide Whether a Share Is a Qualified Small Business Corporation Share
All three must be met, and all three sit in the definition of “qualified small business corporation share” in subsection 110.6(1) of the Income Tax Act.
Paragraph (a) is the sale-date test. At the determination time, the share must be “a share of the capital stock of a small business corporation owned by the individual, the individual’s spouse or common-law partner or a partnership related to the individual”. Paragraph (b) is the ownership test: throughout the 24 months immediately before, the share must not have been owned by anyone other than the individual or a related person or partnership. Paragraph (c) is the 24-month asset test: for that part of the 24 months while the share was so owned, the company had to be a CCPC with “more than 50% of the fair market value of the assets” attributable to active-business assets, or to shares or debt of connected corporations meeting a similar test.
The 90% is in none of that. It arrives through paragraph (a), because “small business corporation” is itself defined. Subsection 248(1) of the Income Tax Act calls it a CCPC where “all or substantially all of the fair market value of the assets” is attributable to active-business assets, shares and debt of connected small business corporations, or both. CRA is what puts a number on the phrase: page 9 of Guide T4037, Capital Gains describes a small business corporation as a CCPC in which “all or most (90% or more) of the fair market value of its assets” are so used. The 90% is CRA’s reading, not statutory text.
| What is tested | The threshold | The window |
|---|---|---|
| Asset value on the active-business side, s.248(1) via s.110.6(1)(a) | 90% or more (CRA’s reading of “all or substantially all”) | At the moment of sale only |
| Asset value on the active-business side, s.110.6(1)(c) | More than 50% | Throughout the 24 months before, while owned by the individual or a related person |
| Who owned the share, s.110.6(1)(b) | Only the individual or a related person or partnership | Throughout the 24 months before |
Paragraph (d) of the same definition adds a qualification for anyone holding shares through a second corporation: in a two-tier structure it can read the “more than 50%” test on a connected corporation as “all or substantially all”. It tightens the test rather than loosening it.
The first two rows belong together. The asset tests are forty percentage points apart and measured over different windows, so a company can run for years at 60% active assets and still qualify if the balance sheet is right before closing, while a perfect balance sheet on closing day does nothing after two years at 45%.
Which side of the line an asset falls on is a question about its use, not its asset class. Subsection 248(1) asks whether it is “used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it”, answered item by item. Cash beyond what the business uses has to answer it, as does a portfolio of marketable securities, a building leased to someone else, and a corporate-owned policy on the life of a shareholder, which subparagraph 110.6(15)(a)(i) deems to be worth its cash surrender value at any time before the death of the insured. None of them can be sorted by a label.
The Sale-Date Test Costs $303,239.76 When It Fails
One taxpayer runs through the rest of this piece: an Ontario resident in 2026 with $60,000 of other income and a $1,275,000 capital gain on private shares.
| Shares qualify | Shares do not | |
|---|---|---|
| Taxable income | $60,000.00 | $697,500.00 |
| Regular federal tax | $6,419.95 | $202,074.99 |
| Ontario tax, surtax and health premium | $3,224.52 | $126,627.95 |
| Federal minimum tax added | $46,059.32 | $33,366.78 |
| Ontario minimum tax added | $11,344.41 | $8,218.24 |
| Total tax on the year | $67,048.20 | $370,287.96 |
The difference is $303,239.76, or 23.78% of the gain.
The qualifying column is not zero, and that total is not what the gain costs. The same taxpayer with no sale at all pays $6,192.73 of federal tax and $3,224.52 to Ontario, $9,417.25 in all. The fully exempt gain adds $57,630.95 to that, of which $57,403.73 is minimum tax, worked through on this same taxpayer in our piece on the alternative minimum tax. The other $227.22 is the federal basic personal amount falling from $16,452 to $14,829, because net income carries the taxable half of the gain even though the deduction removes it from taxable income. A gain the exemption covers in full still costs $227.22.
Minimum tax reaches the failing column too: subparagraph 127.52(1)(d)(i) has the fraction in paragraph 38(a) read as “1/1”, so the untaxed half of any capital gain goes back into the base whether or not the exemption was claimed. That is the $33,366.78 on the right.
In balance-sheet dollars, a corporation with $1,000,000 of active-business assets passes the sale-date test only while everything else stays at or under $111,111.11, one ninth of the active side. The 24-month test would let it carry just under $1,000,000, and there is no partial credit on the day: the dollar past the line costs the whole $303,239.76.
That $303,239.76 is the cliff at a gain of exactly $1,275,000, and nothing moves it like the size of the gain itself. When the shares qualify the deduction is the lesser of half the gain and $637,500.
| Capital gain | Tax if the shares qualify | Tax if they do not | The cliff | As a share of the gain |
|---|---|---|---|---|
| $250,000 | $9,427.74 | $57,482.30 | $48,054.56 | 19.22% |
| $500,000 | $9,644.47 | $124,225.46 | $114,580.99 | 22.92% |
| $1,275,000 | $67,048.20 | $370,287.96 | $303,239.76 | 23.78% |
| $2,000,000 | $293,388.46 | $600,475.46 | $307,087.00 | 15.35% |
| $3,000,000 | $610,888.46 | $917,975.46 | $307,087.00 | 10.24% |
| $5,000,000 | $1,245,888.46 | $1,552,975.46 | $307,087.00 | 6.14% |
Above roughly $2,000,000 the cliff stops growing. It sits flat at $307,087.00 on gains of $2,000,000, $3,000,000 and $5,000,000, because the deduction is capped at $637,500 and the rest is taxed either way. The exemption is worth the same dollars at $5,000,000 as at $2,000,000, which is why the cliff falls from 23.78% of the gain to 6.14%. The answer also moves a few percent with the rest of the return.
The Ownership Test Runs for 24 Months and a Newly Issued Share Restarts It
Paragraph 110.6(1)(b) is separate from the asset tests and catches people who clear both comfortably. For the full 24 months, nobody outside the individual and related persons or partnerships can have owned the share, so shares bought from an arm’s-length partner 18 months ago fail.
Paragraph 110.6(14)(f) is the trap. It provides that “shares issued after June 13, 1988 by a corporation to a particular person or partnership shall be deemed to have been owned immediately before their issue by a person who was not related to” the holder. The deemed prior owner is unrelated, so a newly issued share starts a fresh 24-month clock. Three exceptions, and only three: shares issued as consideration for other shares; shares issued as part of a transaction in which the person disposed to the corporation of all or substantially all the assets used in an active business they carried on, or an interest in such a partnership; and shares issued as payment of a stock dividend.
The consequence is a date: shares issued on October 17, 2026 cannot support a qualifying disposition before October 17, 2028, and the same clock runs on a balance sheet brought onside today.
One relieving rule sits alongside it at paragraph 110.6(14)(g). A share that would fail paragraph (a) immediately before the individual’s death is deemed to be a qualified small business corporation share if it was one at any time in the 12-month period immediately preceding the death.
A Cumulative Net Investment Loss Comes Off the Cumulative Gains Limit
The shares can pass every test above and the deduction can still fall short, through a mechanism with nothing to do with the company. Page 2 of the 2025 Form T657 makes the deduction the least of four amounts, one of which is the cumulative gains limit. Paragraph (e) of that definition in subsection 110.6(1) reduces the limit by “the individual’s cumulative net investment loss at the end of the year”, a balance the same subsection defines as investment expense since 1988 minus investment income since 1988, cumulatively. Part 1, line 1 of CRA Form T936 is “Carrying charges and interest expenses (line 22100)”; Part 2, line 8 is investment income from lines 12000 and 12100.
A dollar of deductible investment-loan interest never matched by a dollar of investment income is therefore a dollar of exemption that is not there at the sale, as long as the cumulative gains limit is the ceiling that binds, which it is whenever the gain is no larger than the lifetime room left. Since line 22100 is where the form starts, the prior question is whether the interest was deductible at all, which is why we set out when investment loan interest is deductible. The balance is expense minus income, so how each kind of investment income is taxed decides how fast it gets worked off.
The three runs below hold the amounts constant year after year, which no portfolio does.
| Carrying charges and investment income | CNIL after the run | Deduction allowed | Total tax | More than the clean case |
|---|---|---|---|---|
| $10,000 a year against $6,000 of investment income, 15 years | $60,000 | $577,500.00 | $92,162.96 | $25,114.76 |
| $10,000 a year against $2,000 of investment income, 15 years | $120,000 | $517,500.00 | $120,695.72 | $53,647.52 |
| $25,000 a year against $5,000 of investment income, 20 years | $400,000 | $237,500.00 | $255,883.00 | $188,834.80 |
Where the gain is large enough for the $637,500 maximum to bind first, the balance costs nothing: that same $400,000 costs $0.00 on a $5,000,000 gain, where the cumulative gains limit of $2,100,000 sits far above the maximum deduction.
Page 15 of T4037 is blunt about the record keeping: Form T936 must be completed if there was investment income or investment expense in “any years from 1988 to 2025”, and a business owner “should also keep a record of your investment income and expenses in case you decide to claim a capital gains deduction in the year of sale”. The running total starts in 1988.
Failing to Report a Gain Kills the Deduction Against That Gain for Good
Subsection 110.6(6) is short. Where an individual “knowingly or under circumstances amounting to gross negligence” fails to file within a year of the filing due date, or fails to report the capital gain, and the Minister establishes the facts justifying the denial, “no amount may be deducted under this section in respect of a capital gain of an individual for a particular taxation year in computing the individual’s taxable income for the particular taxation year or any subsequent year”. The denial attaches to that capital gain, in that year and in every later year the gain surfaces, which is what makes a reserve worthless once subsection (6) is in play.
Two further denials sit beside it. Subsection 110.6(7) denies the deduction where the disposition is part of a series of transactions or events that includes a dividend received by a corporation to which subsection 55(2) would apply but for paragraph 55(3)(b), or in which property is acquired by a corporation or partnership “for consideration that is significantly less than the fair market value of the property at the time of acquisition”. Subsection 110.6(8) denies it where a significant part of the gain can reasonably be concluded to be attributable to dividends not having been paid on a share other than a prescribed share, or paid at less than 90% of “the average annual rate of return on that share for that year”. That one reaches preferred shares issued in an estate freeze.
What Is Still Editable, and What Is Not
Only one of the two windows is still editable when a deal is on the table. If the asset mix was wrong across the 24 months, or the shares were issued inside it, closing day was settled long before closing day. An owner whose shares will not qualify usually asks next whether the gain can at least be spread over several years: the capital gains reserve is where that goes. It spreads the gain without enlarging the lifetime total, because subsection 110.6(31) reduces the amount deductible in a later year by the excess over what would have been deductible had no reserve been claimed.
Figures and statutory text as of October 17, 2026. The Income Tax Act is cited as consolidated current to September 30, 2026, CRA’s indexation page was last modified March 12, 2026, and T4037, T657 and T936 are cited in their 2025 editions.
Disclaimer: The content on bestcanadianstocks.ca is for informational and entertainment purposes only and does not constitute financial advice. Past performance is not indicative of future results. Always consult a qualified financial advisor before making investment decisions. The three conditions for a qualified small business corporation share, the definition of a small business corporation, the deeming rule for shares issued after June 13, 1988, the life insurance valuation rule, the cumulative gains limit and the failure-to-report bar are quoted from the Income Tax Act as consolidated on the Justice Laws website, current to September 30, 2026 and last amended June 18, 2026. The 90 percent reading of all or substantially all, and the plain-language statement of the three conditions, are from the Canada Revenue Agency’s Guide T4037, Capital Gains, 2025 edition, page 9, with the capital gains deduction and record-keeping material at pages 14 and 15. The four ceilings on the deduction are from CRA Form T657, 2025 edition, page 2, and the components of a cumulative net investment loss are from CRA Form T936, 2025 edition. The 2026 lifetime capital gains exemption of 1,275,000 dollars, the 637,500 dollar deduction limit and the 2.0 percent indexation factor are from the CRA indexation adjustment table, last modified March 12, 2026. Ontario brackets, the surtax thresholds, the health premium and the basic personal amount are from CRA’s T4032ON payroll deductions tables for January 2026. Every tax total, the 303,239.76 dollar difference, the balance sheet headroom figures and the cumulative net investment loss runs are our own arithmetic on those published rates and limits, for an Ontario resident with 60,000 dollars of other income, cross-checked against the figures this site published on October 15, 2026.
