How to Do Section 85 Rollovers: a Complete Guide

Section 85 Rollovers: Overview and Key Concepts

Ever wish you could move assets into your corporation without triggering an immediate tax bill? That’s precisely what a Section 85 rollover allows you to do. This powerful provision of the Canadian Income Tax Act enables individuals, partnerships, or trusts to transfer eligible property to a Canadian corporation on a tax-deferred basis.

Think of it as hitting the “pause” button on capital gains. Instead of paying tax right away when property like shares, land, or equipment changes hands, a Section 85 election allows you to defer the tax until the shares received from the corporation are eventually sold. This flexibility is invaluable for business restructuring, estate planning, or simply optimizing your corporate structure.

The key involves an “elected amount” chosen between the asset’s cost and its fair market value, ensuring no immediate gain or loss. Understanding this mechanism is crucial for maximizing your tax savings.

Eligibility Criteria for Transferors, Transferees, and Property

Understanding who can use a Section 85 rollover, who can receive the property, and what types of property qualify is absolutely essential. Think of it like assembling a puzzle; if even one piece doesn’t fit, the whole picture falls apart, and your tax deferral could vanish!

Let’s break down these critical eligibility requirements to ensure your transfer is set up for success.

Who Can Transfer (The Transferor)?

The “transferor” is the individual or entity moving the property into a corporation. For a Section 85 rollover to apply, the transferor must be:

• An individual: This is very common, perhaps an entrepreneur incorporating their sole proprietorship, a process often guided by robust tax planning and structuring for startups.
• A partnership: Partners can collectively transfer property from their partnership to a corporation.
• A trust: Trusts can also utilize a Section 85 election for qualified property transfers.

In essence, if you’re a person or a non-corporate entity looking to incorporate your business assets, you’re likely eligible as a transferor.

Who Can Receive (The Transferee)?

The “transferee” is the business that receives the property. This part is quite specific: the transferee must be a taxable Canadian corporation.

• “Taxable”: This means the corporation is not exempt from tax (e.g., a charity wouldn’t qualify).
• “Canadian corporation”: This means the corporation was either incorporated in Canada or was resident in Canada throughout the period from June 18, 1971, to the time of transfer. So, a foreign-incorporated company, even if operating in Canada, generally won’t work for a Section 85 rollover. Understanding this distinction is vital for proper corporate tax compliance.

This requirement ensures that the transferred property remains within the Canadian tax system, maintaining the CRA’s oversight.

What Property Qualifies?

This is where things get really interesting, as not all assets are created equal under Section 85. The goal is to transfer property that could otherwise trigger immediate capital gains or recapture. Understanding how to apply capital gains tax reduction strategies is key here. Here’s a summary of what generally qualifies:

• Capital Property: This includes most business assets like land, buildings, equipment, goodwill (now generally Class 14.1 property for Capital Cost Allowance purposes), and shares of other corporations.
• Inventory: Yes, inventory can qualify, but only if it’s not “resource property” (like mineral rights or timber limits). This is a big one for businesses with substantial stock they want to incorporate.
• Resource Property: Specific types of Canadian resource property may also be eligible.

However, there are important exclusions. You generally cannot roll over:

• Cash
• Accounts receivable (unless elected upon, but this requires specific conditions and can be complex)
• Some types of resource property

The fundamental idea is that the property you’re transferring should be “eligible property” that the corporation can use in its business and that, if sold at fair market value, would generate a gain or recapture for you personally. And crucially, as part of the deal, you, the transferor, must receive shares of the transferee corporation as consideration for the property.

Navigating these specific requirements can be complex, and making an error could be costly. This is why thorough tax due diligence is paramount. It’s always wise to consult with a qualified tax professional to ensure your Section 85 rollover is structured correctly and compliant.

Step-by-Step Section 85 Election Process

Navigating the Section 85 election process might seem like orchestrating a complex symphony, but with a clear roadmap, you can ensure every note is played perfectly. This isn’t just about filling out a form; it’s about strategic tax planning to ensure your business transition is as tax-efficient as possible.

So, where do you begin? Let’s break down the essential steps to successfully elect a Section 85 rollover, ensuring you avoid common pitfalls and maximise your tax savings.

Your Section 85 Rollover Checklist

Consider this your go-to guide for a seamless transition. Each step builds on the last, so careful attention to detail is paramount.

1. Confirm Eligibility

   Before diving in, confirm that both the transferor (you, as the business owner) and the transferee (the Canadian corporation acquiring the assets) meet the criteria. Does the property qualify? Generally, most capital property, inventory (except real property), and eligible capital property can be transferred. Understanding these foundational requirements is your first crucial step.

2. Determine Fair Market Value (FMV)

   This is where precision pays off. You need to accurately determine the Fair Market Value (FMV) of each asset you’re transferring. Why is this so important? The elected amount you choose for the rollover must fall within a specific range, defined by the FMV and the tax cost (Adjusted Cost Base or Undepreciated Capital Cost) of the assets. Getting this wrong can lead to unintended tax consequences.

3. Establish the “Elected Amount”

   This is the heart of the Section 85 election. You, as the transferor, and the corporation agree on a specific “elected amount” for each asset. This amount effectively becomes the proceeds of disposition for you and the cost base for the corporation. The magic here is choosing an amount that defers tax, often at the transferor’s tax cost, as long as it respects the FMV boundaries.

4. Complete CRA Form T2057 (or T2058)

   The Canada Revenue Agency (CRA) form T2057, “Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation,” is the official document for this election. If you’re dealing with a partnership, you’ll use Form T2058. This form requires detailed information about the assets, their FMV, tax cost, and the elected amounts. Accuracy here is non-negotiable. This is a critical aspect of corporate tax strategy.

   For more detailed guidance directly from the CRA, you can refer to their official page for Form T2057.

5. File on Time

   You must file Form T2057 (or T2058) by the earliest filing deadline for any of the parties involved in the election. Typically, this is the filing deadline for your income tax return for the year the transfer occurred. Missed deadlines can mean a penalty or even a voided election, undermining your tax planning efforts. While late filing is sometimes possible with an additional penalty, it’s always best to be punctual.

6. Maintain Meticulous Records

   Once the election is complete, keep all related documentation – valuation reports, transfer agreements, and the filed CRA form – in a safe place. These records are vital for future tax reporting and in case of a CRA review.

Common Pitfalls to Sidestep

Even with a clear process, a few common missteps can trip up business owners. Watch out for:

• Inaccurate Valuations: Under or overvaluing assets can trigger unintended tax.
• Incorrect Elected Amounts: Choosing an elected amount outside the permissible range.
• Missed Filing Deadlines: Procrastination can lead to penalties or even disallowance.
• Incomplete Forms: Simple errors or omissions can delay or invalidate your election.

Navigating these steps can feel like a complex puzzle, so don’t hesitate to consult with a qualified tax professional to ensure everything is handled correctly. An expert can guide you through each stage, providing peace of mind and optimising your tax position.

Provincial and Cross-Border Variations

While Section 85 is a federal provision, provincial tax rules can introduce unique considerations. Quebec, for example, has its own distinct tax legislation, requiring careful alignment with federal provisions. Always ensure your rollover planning accounts for these provincial specifics.

Cross-border scenarios, especially involving the U.S., significantly amplify complexity. A tax-deferred Section 85 rollover in Canada might trigger immediate U.S. tax implications, such as capital gains for U.S. shareholders or on U.S. property. Divergent tax laws and Canadian-US tax treaty interpretations can create unexpected liabilities. Navigating these intricate differences in cross-border taxation requires specialized expertise; therefore, it is always wise to consult with a qualified cross-border tax professional.

Real-World Case Studies and Numeric Examples

Imagine Sarah, a passionate baker, who built her successful sole proprietorship over years. Her business is now worth $500,000, but her original asset cost was just $100,000. If she were to sell these assets directly to a new corporation she’s forming, she’d immediately face capital gains tax on that $400,000 appreciation. That’s a significant tax bill right out of the gate!

Here’s where a Section 85 rollover truly shines. By using this powerful provision, Sarah can transfer her bakery’s assets to her new corporation without triggering immediate tax on the gain. This smart move means she defers the tax payable until she eventually sells those shares, allowing her to retain crucial capital for growth instead of paying it upfront.

Interactive Tools: Fillable Checklist and Tax Calculator

Simplifying Section 85 rollovers is our goal. Practical tools guide you, making the process clear and manageable. Forget guesswork with structured support.

Our fillable checklist offers a step-by-step guide for your Section 85 transaction. It ensures every crucial detail is covered, from asset transfers to share considerations. A clear path, no missed steps.

Curious about financial impact? Our interactive tax calculator helps you estimate potential tax deferral benefits of a Section 85 election. It provides a valuable starting point to understand your savings.

These tools empower your understanding. For personalised advice, always consult with a qualified tax professional to optimise your business structure effectively.

Key Takeaways and Best Practices

Navigating Section 85 rollovers effectively means understanding their power for tax deferral and avoiding common missteps. This strategic tool helps Canadian small businesses restructure ownership or transition assets to a corporation without triggering immediate tax liabilities. But how do you ensure a smooth process?

Here are some best practices to keep in mind:

• Precision is Paramount: Accurate valuation of transferred assets is crucial. Incorrect values can lead to unexpected tax consequences.
• Timely Elections: Always file Form T2057, “Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation,” on time. Missed deadlines can be costly.
• Consider All Angles: A Section 85 rollover impacts more than just immediate taxes; think about future capital gains, dividend planning, and estate considerations.
• Document Everything: Maintain thorough records of all transactions, valuations, and agreements. This documentation is your best defence in case of a CRA review.

While the concept is straightforward, the application can be complex. For personalised guidance tailored to your unique business situation, it’s always wise to consult with a qualified tax professional.

Further Resources and References

Navigating a Section 85 rollover can feel like deciphering a complex puzzle, even with a solid understanding of the fundamentals. The details matter immensely, and the wrong move can have significant tax implications. So, where can you turn for more in-depth information?

Your primary resource for official interpretations is the Canada Revenue Agency (CRA). Their publications and forms are essential for understanding specific requirements and nuances. Always cross-reference your understanding with the latest CRA advisories.

However, no guide can replace tailored advice. For bespoke tax planning, procedural checklists, or insights into common pitfalls, consult with a qualified tax professional. They offer visual aids, case studies, and practical applications specific to your unique situation, ensuring you navigate these complex waters with confidence.

About the Author

Samer Tohme, CPA – Tohme Accounting is a Canadian firm (Ottawa & Toronto) specialising in cross-border Canadian-U.S. tax, corporate tax filing, bookkeeping, GST/HST, and crypto accounting for SMBs and individuals. We take on US and Canadian clients and take on all tax and accounting related work.