The section 85 rollover under the Income Tax Act lets you transfer certain eligible property to a taxable Canadian corporation without triggering tax consequences at the time of the transfer. A section 85 rollover does not erase the tax: it defers it until a future disposition. Here is the problem this mechanism solves, the situations where it is used most often, its core conditions, and why it should never be improvised.
The rollover in a nutshell: deferring tax, not erasing it
The default rule is harsh. When you transfer property to your corporation, the tax authorities generally treat you as having sold it at fair market value, even though no money changes hands. A graphic designer who contributes a client base built over ten years to a new corporation they control would potentially realize an immediate taxable gain, without receiving a dollar to pay it with.
Section 85 opens a door: the transferor and the corporation jointly elect an "agreed amount", which serves both as the sale price for one and the acquisition cost for the other. Set at the property's tax cost rather than its market value, the agreed amount keeps the accrued gain dormant. It resurfaces later, when the corporation sells the asset or when you sell your shares. Quebec runs a parallel regime under the Taxation Act, with its own form.
The classic scenarios: incorporation and reorganizations
The most common scenario is incorporating a sole proprietorship that is already up and running. Equipment, goodwill, a client list: some of these assets are often worth far more than they cost, and the rollover moves them into the new corporation without an immediate tax bill. It is frequently the gateway to the corporation's advantages, including the small business deduction, and to the compensation choices explored in our upcoming salary or dividend article.
The share rollover is the second major case: an entrepreneur transfers the shares of an operating company to a newly created holding company. In most cases, this structure eases the flow of intercorporate dividends and helps keep surplus funds sheltered from day-to-day operations.
The core conditions: eligible property, consideration and the agreed amount
Three conditions shape the mechanism. First, the transferred property must be "eligible property": most capital property, depreciable property and inventory generally qualify, while real property held as inventory is excluded.
Second, the consideration you receive must include at least one share of the corporation. It can also include something else, a promissory note for instance, which tax practitioners call non-share consideration, or boot.
Third, the agreed amount is not a free choice: it is subject to a floor and a ceiling set by the statute. For example, you cannot deliberately trigger a capital loss by using the section 85 rollover.
Forms T2057 and TP-518: a formal election with deadlines
The rollover only exists if the election is filed. Federally, the transferor and the corporation sign form T2057, due no later than the earliest filing deadline of the parties' income tax returns for the year of the transfer. A late election may be accepted within certain limits, subject to a penalty. In Quebec, an election must be filed with Revenu Québec on form TP-518.
The rollover also requires the preparation of the appropriate legal documentation, including a transfer agreement, resolutions of the board of directors and the issuance of the shares of the transferee corporation. A reasonable determination of the fair market value of the property being rolled over is required.
The pitfalls that make professional advice indispensable
A poorly calibrated rollover is expensive. An unreasonable valuation can confer a benefit on a related person and cause immediate tax consequences; a well-drafted price adjustment clause reduces that risk without removing it entirely.
Add to this the paid-up capital computation on the shares issued and the GST and QST questions raised by asset transfers, for which a joint election is sometimes available. This article explains concepts; it does not replace an analysis of your situation. This article does not constitute a legal or tax opinion in any way and is presented for general educational information purposes only. Our team handles this type of operation through its tax and corporate law services.
FAQ
Q: Does the section 85 rollover eliminate the tax on my assets?
A: No. It defers taxation of the accrued gain until a future disposition of the property or of the shares received in exchange.
Q: Do I need to file a Quebec form on top of the federal T2057?
A: Yes. A Quebec taxpayer also files form TP-518 with Revenu Québec.
Q: Is the rollover only for large businesses?
A: Not at all. It is commonly used by small and medium-sized businesses, notably when incorporating an existing sole proprietorship.
Thinking about incorporating your existing business or setting up a holding company? Contact our team to assess whether a section 85 rollover fits your situation.
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