Are you an Alberta business owner looking to transition your sole proprietorship into a corporation, or planning a corporate restructuring? If so, you may be wondering how to move valuable business assets without triggering an unexpected tax bill.
Under normal tax rules, transferring property that has increased in value to a corporation can trigger tax on the gain or recapture of depreciation. This can be an important consideration when moving assets such as equipment, goodwill, commercial real estate, or certain investments into a corporation.
Fortunately, Section 85 of the Income Tax Act provides a way to defer tax on certain eligible property. A Section 85 rollover can allow you to transfer eligible property to a taxable Canadian corporation on a tax-deferred basis when the required conditions are met.
The tax is generally deferred rather than eliminated. The transferor and receiving corporation jointly choose an Elected Amount, which determines the tax treatment of the transfer under the Section 85 rules.
In this guide, we'll explain how Section 85 rollovers work, when they may be useful, and the key rules business owners need to understand before completing a corporate restructuring.
A Section 85 Rollover is a provision under the Canadian Income Tax Act that allows a taxpayer to transfer eligible property to a taxable Canadian corporation in exchange for consideration that includes shares.
Instead of having to report the property's full accrued gain right away, the transferor and receiving corporation jointly choose an agreed-upon amount called the Elected Amount.
The Elected Amount generally becomes the transferor's proceeds of disposition and the corporation's tax cost of the transferred property. By selecting an appropriate elected amount, the transaction can generally occur on a tax-deferred basis.
The tax liability is not eliminated. Instead, the tax consequences associated with the property's accrued gain can be deferred until a later taxable disposition or other event.
As your business grows, you may eventually need to change how your company is structured. Section 85 rollovers can be part of a broader strategy for managing business assets, investments, financing, succession, and tax planning.
If your operating company holds significant investments, cash reserves, or commercial real estate, you may consider whether those assets should remain in the operating company or be held separately.
Transferring eligible property to a separate holding company may allow certain assets to be separated from the company's day-to-day operations while deferring the immediate tax consequences of the transfer.
However, Section 85 itself does not provide creditor protection. The legal and creditor-protection implications of moving assets between corporations depend on the circumstances, including corporate structure, guarantees, security interests, timing, and applicable law. Business owners should obtain appropriate legal and tax advice before undertaking a restructuring.
If you are considering selling your corporate shares in the future, you may also need to consider the requirements for the Lifetime Capital Gains Exemption (LCGE).
For shares to qualify as qualified small business corporation shares, specific tests must be met. These include rules about who owns the shares and how the corporation's assets are used during the 24 months before the sale, as well as how the assets are used immediately before the sale.
Excess passive investment income or other non-qualifying assets can therefore create tax-planning issues when a business owner is preparing for a potential sale.
A corporate reorganization may be one way to address non-qualifying assets, but the right approach depends on the company's circumstances. This type of planning should generally be considered well before a potential sale.
If you run a successful sole proprietorship, moving to a corporation can be an important step as your business grows.
Section 85 may allow certain eligible business property, including qualifying equipment, inventory, and business goodwill, to be transferred to a newly incorporated company on a tax-deferred basis when the required conditions are met.
This can help a business owner incorporate without necessarily triggering the full immediate tax consequences that could otherwise arise from transferring appreciated eligible property.
A Section 85 rollover must meet specific rules under the Income Tax Act. The type of property being transferred and the consideration received can affect how the rollover works.
Not every type of property qualifies for a Section 85 rollover. Eligible property can include certain capital property, inventory, Canadian and foreign resource property, and other property listed under subsection 85(1.1) of the Income Tax Act.
Importantly, real or immovable property held as inventory is generally excluded. This means you need to look at the type of property and how it is classified for tax purposes before assuming it qualifies for a Section 85 rollover.
The transfer must include shares of the receiving taxable Canadian corporation as part of the consideration.
Section 85 is therefore not simply a way to transfer an asset from one corporation to another in exchange for cash. The transaction must meet the rules for the consideration received and the joint election.
In addition to shares, the transferor may receive non-share consideration, such as cash or a promissory note.
The amount and fair market value of this non-share consideration can affect the minimum Elected Amount. In some cases, this can result in an immediate taxable gain if the Elected Amount must be higher than the property's tax cost.
The rules can vary depending on the type of property being transferred. Business owners should therefore avoid assuming that "boot" has one universal tax limit based only on the property's Adjusted Cost Base (ACB).
The Elected Amount cannot simply be chosen at random.
Section 85 contains statutory minimum and maximum limits that vary depending on the type of property being transferred.
Generally:
These rules mean that the appropriate Elected Amount must be determined based on the specific property and consideration involved rather than by applying a single formula to every Section 85 transaction.
A Section 85 rollover is not automatically recognized simply because an asset changes hands. The transaction must satisfy the statutory requirements, and the required election must be properly completed and filed.
The process generally involves three key steps:
The transferor, such as an individual, partnership, or corporation, transfers eligible property to the receiving taxable Canadian corporation.
In exchange for the property, the receiving corporation issues shares to the transferor, potentially alongside permitted non-share consideration such as cash or a promissory note.
The transferor and receiving corporation jointly complete the prescribed election, generally using CRA Form T2057 for a subsection 85(1) transfer.
The election identifies the property being transferred and the agreed Elected Amount. Under Section 85, that elected amount becomes the transferor's proceeds of disposition and the corporation's cost of the property, subject to the statutory rules.
The Section 85 election is generally due on or before the earliest date on which any taxpayer making the election is required to file an income tax return for the taxation year in which the transaction occurred.
Late elections may be accepted in certain circumstances. Under the Income Tax Act, a late election can generally be filed within three years of the original deadline if the prescribed requirements are met and the applicable penalty is paid.
In some cases, the Minister may also allow an election or amended election after that three-year period if the requirements under the Income Tax Act are met.
Because late elections can result in penalties and additional complications, businesses should have the Section 85 election prepared and filed within the applicable deadline whenever possible.
Section 85 can be a valuable tool for corporate restructuring, but the rules are technical and the tax consequences depend heavily on the type of property transferred, the consideration received, the corporate structure, and the Elected Amount.
Errors in valuation, share consideration, property classification, or the election itself can result in unintended tax consequences.
At Jensen CPA, we help Alberta businesses navigate corporate tax planning, restructuring, and ongoing financial management.
If you are considering a Section 85 rollover or another corporate restructuring, the next step is to speak with a tax professional about your specific situation. Our Calgary corporate tax team can help you understand the potential tax implications and determine what planning options may be appropriate for your business.
Contact Jensen CPA to discuss your situation and take the next step with our team.
Government of Canada — Income Tax Act, Section 85: Exchanges of Property for Shares
Provides the legislation governing Section 85 rollovers, including eligible property, elected amounts, non-share consideration, and the requirements for making a joint election.
Canada Revenue Agency — Transfer of Property to a Corporation Under Section 85 (IC76-19R3)
Explains how Section 85 elections work, including eligible property, consideration received, elected amounts, and common requirements when transferring property to a corporation.
Canada Revenue Agency — Qualified Small Business Corporation Shares
Explains the requirements for shares to qualify as qualified small business corporation shares, including the 24-month asset-use tests and active-business asset requirements relevant to the Lifetime Capital Gains Exemption.
Canada Revenue Agency — Form T2057: Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation
Provides the prescribed CRA form used by taxpayers and taxable Canadian corporations to make a joint Section 85 election.
Canada Revenue Agency — Income Tax Audit Manual: Transfers of Property to a Corporation Under Section 85
Provides CRA technical guidance on Section 85 transfers, including eligible property, elected-amount limits, non-share consideration, and the tax treatment of different types of property.
Author: Written by the Jensen CPA Editorial Team, reviewed & approved by Managing Partner Kevin Jensen.
Disclaimer: The information provided in this article is for general informational and educational purposes only and does not constitute professional accounting, tax, financial, investment, or legal advice. Reading this article does not create an accountant-client relationship with Jensen CPA. Canadian and Alberta tax laws are complex and subject to change. Always consult a qualified CPA or other appropriate professional regarding your specific business or financial situation. Read our full Terms of Use.
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