What is a section 85 rollover?
Overview
The section 85 rollover is an election in the Canadian Income Tax Act that permits a taxpayer to transfer eligible property on a tax deferred basis to a taxable Canadian corporation. In a nutshell, this election allows a taxpayer to defer all or part of the tax consequences that would normally arise on the transfer, depending on their objectives.
The section 85 rollover is often used in, but not limited to, the following situations:
- Sole proprietors who are looking to incorporate their business
- Estate planning
- Capital gains crystallization
- Transfer of assets from one business to another
Qualification requirements
First, to qualify for the section 85 rollover, there must be an eligible transferor and transferee. An eligible transferor is defined as any taxpayer, including individuals, corporations, and trusts. An eligible transferee must be a taxable Canadian corporation. This typically requires the corporation to be incorporated in Canada.
Secondly, the property transferred must be eligible property.
Eligible property includes the following:
- Depreciable and non-depreciable capital property
- Inventories, except real property held as inventory
- Canadian/foreign resource property
- Real estate property owned by non-residents used to carry on business in Canada
Finally, the consideration that the transferor receives on the transfer must include shares of the transferee. As part of the consideration, the transferor may also receive non-share consideration, commonly referred to as “boot”. The fair market value (FMV) of the boot received cannot exceed the tax cost of the property transferred, otherwise it will trigger a capital gain. Common non-share consideration includes cash, or a note receivable. FMV of the transferred assets must equal the FMV of the total consideration received.
How it works
To execute a section 85 rollover, the transferor and transferee must agree on the elected amount on the transfer. The elected amount is the transferor’s proceeds of disposition and the transferee’s cost of the property acquired.
The elected amount cannot be:
- Less than the FMV of the boot; or
- Greater than the FMV of the property being transferred.
If the taxpayer is transferring inventories or non-depreciable capital property, the lower range of the elected amount cannot be less than the lesser of:
- FMV of property; and
- Tax cost of the inventories or adjusted cost base (“ACB”) of the property.
If the taxpayer is transferring depreciable property, the lower range of the elected amount cannot be lesser than the lesser of:
- FMV of property;
- ACB; and
- Undepreciated capital cost.
In most cases, you would elect at tax cost or ACB resulting in a tax-free rollover. However, there could be situations where you would consider electing at a higher amount to purposely trigger gains (e.g., utilizing loss carryforwards, or crystalizing the capital gains exemption).
Scenarios
You’re looking to transfer non-depreciable capital property from your sole proprietorship to your newly incorporated Canadian company in exchange for its common shares. The property has an ACB of $100,000 and FMV of $300,000
Without a section 85 rollover
If you do not elect to transfer under section 85, you would need to report a disposition of the capital property at its FMV. This would result in a capital gain of $200,000 ($300,000-$100,000) on your personal tax return.
With a section 85 rollover
Alternatively, if you utilize section 85, you could transfer the capital property at the ACB of $100,000 (elected amount). There would be no capital gain arising from the transfer of the property, resulting in no immediate tax consequences. Assuming that there is no boot taken as consideration, the ACB of the common shares becomes the elected amount of $100,000. The corporation will have capital property with an ACB of $100,000. A summary of the transaction is illustrated below.
Important: Keep in mind that this does not exempt the transferor from paying tax on the accrued gain. Rather, it defers the tax related to the capital gain until the subsequent sale of capital property in the future.
Filing deadline and specifications
This joint election must be made to the CRA on prescribed Form T2057. This form is due the earlier of the income tax return filing deadline of the transferor or transferee for the taxation year that the transfer occurred. The form should be filed separate from any other returns and addressed to the transferor’s tax centre. If several transferors are involved in the transaction of the same property, one designated transferor can file all of the completed election forms on behalf of each transferor along with a list of the transferors involved to the corporation’s tax centre.
CRA will accept the late filing of this form if it is filed within three years from the original due date of this form so long as the taxpayer includes an estimated payment of the penalty at the time of filing.
If the form is filed after the three-year time period, in addition to the above, the taxpayer must include written justification for the delayed filing. The CRA will then exercise its discretion in determining whether the late filed election will be accepted.
If you are considering transferring capital property to a corporation and would like to discuss the Canadian tax implications and planning options available, the Tax group at Fuller Landau is ready to answer your questions.
About the authors
David Liang, CPA is a Manager in our Tax group. He can be reached at 647-417-0372 or dliang@fullerllp.com.
Jessica Hum was a Junior Tax Specialist in our Tax Group during her 2021 co-op term. She is currently completing her Bachelor of Accounting and Financial Management at the University of Waterloo.