How to "Purify" Your Business to Minimize Capital Gains Tax
If you're planning to sell your business and want to minimize capital gains tax, you need to ensure your company qualifies for the Lifetime Capital Gains Exemption (LCGE). This requires "purifying" your business—a tax planning strategy that helps your corporation meet the Qualified Small Business Corporation (QSBC) criteria.
Here's what you need to know about business purification and how to implement it effectively.
What Is Business Purification?
Purification is the process of restructuring your business to ensure it meets the 90% active business asset test, which is required to claim the LCGE (currently $1.25 million as of 2024).A business is "pure" when at least 90% of its assets are actively used in operations at the time of sale. If passive investments (like cash, stocks, or real estate) make up too much of your corporation’s assets, the business won’t qualify for the exemption.
Step-by-Step Guide to Purify Your Business for Capital Gains Tax Savings
1. Identify Non-Qualifying Assets
Start by reviewing your company's balance sheet and identifying passive assets that could disqualify your business from the QSBC status. These often include:
💰 Excess cash not required for daily operations
📈 Investments in stocks, bonds, or mutual funds
🏢 Real estate not used in business operations
💵 Loans and receivables from unrelated businesses
📌 Goal: Reduce or restructure these assets to meet the 90% active business asset test.
2. Pay Out Excess Cash as Dividends or Bonuses
If your business is holding a large amount of cash or retained earnings, consider:
Paying dividends to shareholders to distribute the excess cash.
Issuing bonuses to key employees or yourself to reduce retained earnings.
🚨 Caution: Ensure payments are structured properly to avoid triggering unnecessary tax liabilities.
3. Transfer Passive Investments to a Holding Company
If your corporation owns passive investments (like stocks, bonds, or rental properties), you may be able to move them to a separate holding company.
How It Works:
Your operating company (OpCo) transfers passive assets to a holding company (HoldCo) through a tax-efficient reorganization.
This helps your OpCo meet the QSBC active business asset test while keeping investments under HoldCo.
📌 Tip: Work with a tax professional to structure this correctly and avoid unintended tax consequences.
4. Use Capital to Expand Business Operations
Reinvesting excess cash into business operations helps increase the percentage of active business assets. Consider:
🚀 Expanding operations (new equipment, technology, inventory, marketing).
🏢 Purchasing commercial property for business use.
👨💼 Hiring more employees to support business growth.
These strategies reduce passive assets while improving the company’s long-term value.
5. Repay or Restructure Shareholder Loans
If your company has large shareholder loans, they may count as non-active assets. You can:
Repay outstanding loans to clean up the balance sheet.
Convert loans into equity to improve the company’s financial structure.
📌 Why It Matters: Loans and receivables from non-arm’s-length parties may disqualify your company from the LCGE.
6. Time the Sale Strategically
If your business does not currently meet the QSBC criteria, purification must be done at least 24 months before selling to meet the 50% active asset rule.
⏳ Key Timing Rules:
50% active business rule: Applies for at least 24 months before the sale.
90% active business rule: Must be met at the time of sale.
Plan purification well in advance to ensure tax savings when you sell.
Final Thoughts: Why Business Purification Matters
By purifying your business, you can:
Qualify for the $1.25M LCGE and save on capital gains tax.
Increase business valuation by removing unnecessary passive assets.
Reduce future tax liabilities with proper structuring.
📩 Thinking of selling your business? Reach out today, and we’ll help you explore your options!
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