Multiplication of Lifetime Capital Gains Exemption with a Trust
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A family trust that is properly structured and implemented can serve as an effective legal means to multiplying the application of the Lifetime Capital Gains Exemption (LCGE). Since the LCGE is an individual tax benefit (valued at $1.275 million as of January 2026), a trust can be structured to hold shares of a Qualifying Small Business Corporation (QSBC). When these shares are sold, the trust realizes the capital gain but can allocate portions of that gain to its beneficiaries (e.g., a spouse and children). Each beneficiary can then apply their personal LCGE against their allocated portion, effectively shielding millions of dollars from tax that would otherwise be payable if the gain were realized by a single individual.
The implementation of this accepted tax strategy typically begins with an estate freeze, where the current owner exchanges their common shares for fixed-value preferred shares, allowing future growth to accrue to new common shares held by the family trust. For this to be effective, the corporation must meet strict purification tests; specifically, at the time of sale, 90% or more of the fair market value of the assets must be used in an active business in Canada. If the company accumulates too much passive cash or non-business investments, the shares may lose their QSBC status, potentially nullifying the multiplication strategy unless the business is purified prior to the transaction.
Despite its benefits, the Tax on Split Income (TOSI) rules represent a significant hurdle for income splitting. While capital gains from the sale of QSBC shares are generally excluded from TOSI, allowing even minor children to technically utilize their LCGE, the rules for other types of trust distributions (like dividends) are far more restrictive. For adult beneficiaries to avoid being taxed at the highest marginal rate on regular income, they must often meet excluded business criteria, such as working an average of 20 hours per week in the business during the year or in any five previous years [more on TOSI strategies].
Furthermore, attribution rules under the Income Tax Act (Canada) can undermine the trust's tax-efficiency if not carefully managed. For example, Section 75(2) (the reversionary trust rule) can trigger if the person who settled the trust retains too much control over the assets or if the assets can revert back to them; in such cases, all capital gains are attributed back to the settlor, preventing multiplication. Additionally, corporate attribution rules may apply if an individual transfers property to a corporation to benefit a spouse or minor child, potentially resulting in a deemed interest inclusion for the transferor if the corporation is not a Small Business Corporation at all times [more on attribution rules].
Than there is the Income Tax Act (Canada) imposing a long-term shelf life of only 21 years on the trust’s primary tax-deferral benefits. Every 21 years, a trust is deemed to have disposed of its capital property at fair market value, which can trigger massive tax liabilities on unrealized gains even if no sale has occurred. To mitigate this, trustees often "roll out" the shares to beneficiaries at their original cost base before the 21st anniversary. However, this transfer must be handled with precision to ensure that the beneficiaries, rather than the trust, are the ones who eventually claim the LCGE upon an actual third-party sale [more on trust roll-out strategy].
Contact our law firm today to learn how our legal team can help you plan for the future, including wills, trusts, powers of attorney, personal directives and other estate planning documents, or deal with the legal demands associated with the passing of a loved one. Contact our law firm at 403-400-4092 or via email at Chris@NeufeldLegal.com to schedule a confidential initial consultation.
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