Section 85 Rollover: Moving Assets Into Your Corporation Tax Free

What a Section 85 Rollover Does, in One Paragraph

You have been running a business as a sole proprietor for six years. It is worth $300,000 now, most of that goodwill you built yourself. Incorporating sounds sensible until someone points out that transferring the business to a corporation is a sale at fair market value, and you have just triggered a large tax bill on money you never received. Section 85 of the Income Tax Act lets you transfer property to a Canadian corporation and choose the amount at which the transfer happens for tax purposes, rather than being forced to use fair market value.

When You’d Use One

Incorporating a proprietorship. The most common case. You move the business, its goodwill, equipment and sometimes inventory into a new corporation without triggering tax on accrued value. If you are still deciding whether to incorporate at all, start with switching from sole proprietor to corporation and what it costs to incorporate in BC. Estate freezes. Locking in today’s value of your company in fixed value preferred shares so future growth accrues to the next generation or a family trust. Where children or a spouse will hold the growth shares, the tax on split income rules decide whether the eventual dividends are taxed at their rate or yours.

Reorganisations. Moving assets between related corporations, separating real estate from an operating business, or purifying a company so its shares qualify for the lifetime capital gains exemption. This is also how investments usually end up in a holding company. Crystallising the exemption. Deliberately electing above your tax cost to trigger a gain you can shelter with the lifetime capital gains exemption while you still qualify, locking in a higher cost base. The exemption depends on your shares qualifying at the time of sale, and companies drift out of qualification. Crystallising captures it while the tests are met.  

What Property Qualifies, and What Doesn’t

Cash is the one that trips people up. There is no gain on cash, so there is nothing to defer, and you simply contribute it. Accounts receivable have their own rule. Rolling them under section 85 usually produces a capital loss treatment that is unhelpful, so a section 22 election is normally made alongside so the corporation can deduct future bad debts and the seller claims the loss as ordinary.  

Choosing the Elected Amount: The Floor and the Ceiling

The elected amount is the whole decision, and it is boxed in by three rules.

Set the elected amount equal to your tax cost and you get a full deferral. Set it higher and you deliberately realise a gain, which is what crystallisation planning does. For depreciable property there is an extra wrinkle: the elected amount also cannot exceed the original capital cost, which prevents you from stepping up beyond what was actually paid.  

Boot: How Much Non Share Consideration You Can Take Tax Free

Boot is anything you receive that is not shares, most often a promissory note from the corporation or a liability the corporation assumes. Boot is useful because it lets you withdraw cash from the corporation later, tax free, as repayment of the note. The rule is simple and unforgiving: boot up to your tax cost is fine, boot above it triggers a gain. If your property has an adjusted cost base of $40,000 and you take a $70,000 promissory note, the elected amount is deemed to be at least $70,000 and you have a $30,000 gain.

So the standard structure is boot equal to tax cost, with shares absorbing all of the unrealised gain. That gives you a tax free withdrawal channel worth exactly your original investment, and defers everything else. Repaying that note is not the same thing as a shareholder loan drawn from the company, and the two should not be mixed in the same account.  

Filing Form T2057: Deadlines, Late Filing Penalties and Amendments

The election is made on Form T2057, signed by both you and the corporation. One form per property, or a summary with schedules where several properties move together. The deadline is the earlier of the transferor’s and the corporation’s tax return due dates for the year the transfer happened. Note that it is the earlier, not the later, and it is driven by the transfer date rather than by when the paperwork was drafted. Late filing is permitted for up to three years with a penalty, generally the lesser of $100 per month late and $8,000.

Beyond three years, acceptance is at CRA’s discretion, and missing it entirely means the transfer happened at fair market value with the full tax that section 85 existed to prevent. Amendments are possible where the original election contained an error, but relief is discretionary and easier to obtain when the mistake was genuine and promptly corrected.  

Worked Example: Rolling a $300,000 Business Into a New Corporation

You transfer your proprietorship to a new corporation. The business has:

You elect at $25,000, which is your tax cost, and take consideration of a $25,000 promissory note plus shares worth $275,000. The results:

• No tax today. The elected amount equals tax cost, and boot does not exceed it.
• The corporation’s tax cost in the equipment is $25,000 and in the goodwill is nil.
• Your shares have an adjusted cost base of nil, carrying the $275,000 of deferred gain.
• You can draw $25,000 out of the corporation tax free as repayment of the note whenever cash allows.

Change one variable: take a $60,000 note instead. Now boot exceeds tax cost by $35,000, the elected amount is pushed to $60,000, and you have realised $35,000 of income you did not need to.

Section 85 vs Section 86 vs Section 51: Which Rollover You Need

The practical distinction: section 85 moves assets in from outside, section 86 and section 51 rearrange what is already inside a single corporation. Estate freezes are done both ways, with section 86 preferred where the freeze can be achieved by exchanging existing shares, and section 85 used where property is coming from a shareholder or another entity.  

The Errors That Turn a Rollover Into a Taxable Sale

• Boot above tax cost. The most common and most avoidable.
• Missing the T2057 deadline. The deadline is driven by the transfer date, so a rollover done in January can have a filing deadline long before anyone thinks about the return.
• No price adjustment clause. If CRA later revalues the property, a clause allowing the consideration to adjust prevents a deemed shareholder benefit. Without one, a valuation dispute becomes a tax assessment.
• No shares issued. Consideration of only a note fails. At least one share must be issued, and the issuance has to appear in the corporate minute book and securities register.
• Ignoring section 84.1. Transferring shares to a corporation you do not deal with at arm’s length can convert what you expected to be a capital gain into a deemed dividend.
• Skipping the section 22 election on receivables.
• No supporting valuation. Fair market value has to be defensible, especially for goodwill, which is why a proper business valuation is part of the file rather than an afterthought.

Almost every one of these is a planning failure, not a computational one, which is why the design of the transaction matters more than the form itself. If you are thinking about incorporating an existing business or restructuring shares, this is worth modelling before anything moves. Maxpro Financials runs section 85 feasibility reviews for BC business owners, covering valuation, elected amount, boot sizing and the filing calendar, so the deferral you expect is the deferral you get.  

FAQ: Section 85 Rollovers in Canada

Do I need a section 85 rollover to incorporate?

Only if your business has accrued value. If you are starting fresh with no goodwill and no appreciated assets, you can simply incorporate and begin operating in the new company.  

What is the T2057 deadline exactly?

The earlier of the transferor’s and the corporation’s tax return due dates for the tax year in which the transfer occurred.  

What happens if I file late?

Late filing within three years is generally accepted with a penalty of the lesser of $100 per month and $8,000. Beyond that, it is at CRA’s discretion.  

Can I take cash out of the corporation as part of the rollover?

Yes, as boot, but only up to your tax cost in the property. Above that you trigger a gain.  

Does a section 85 rollover need a formal valuation?

For anything with meaningful goodwill or hard to value assets, yes. A price adjustment clause is standard alongside it.  

Can I roll my personal residence into a corporation?

Personal use property does not qualify, and doing so would lose the principal residence exemption. This is almost never advisable.  

Is a rollover reversible?

Not easily. Unwinding creates its own tax consequences, which is why the structure should be right the first time.  

Who signs the T2057?

Both the transferor and the corporation. It is a joint election and needs both signatures.  

Can I use section 85 to crystallise the capital gains exemption?

Yes, by electing above your tax cost to trigger a gain that the exemption shelters. It requires the shares to qualify at that time.  

How much does a section 85 rollover cost to do properly?

It is a combined legal and accounting engagement covering valuation, share structure, documents and the election. Price it as a project, and weigh it against the tax it defers.  

Thinking About Incorporating? Get a Section 85 Feasibility Review