Income Tax and Section 85 Rollovers

The Section 85 rollover of capital property in Canada is a provision in the Income Tax Act that allows a taxpayer to transfer certain capital property to a corporation on a tax deferred basis. This means that the transferor (an individual, partnership, or corporation) can defer recognition of any capital gains that would otherwise be triggered by transferring the property. Section 85 rollovers are commonly used in situations like estate freezes, corporate reorganizations, or incorporating a sole proprietorship.

Key Elements of the Section 85 Rollover

Eligibility of Property:

• Section 85 applies to various types of capital property, including real estate, shares, partnership interests, and eligible capital property.
• Inventory and depreciable property can also qualify, with special rules for depreciable property.

Transfer of Property to a Corporation:

• The taxpayer (transferor) must transfer the property to a taxable Canadian corporation.
• The corporation issues shares (and possibly other consideration, such as promissory notes) to the taxpayer in exchange for the property.

Electing an Agreed Amount:

• The taxpayer and the corporation must file a joint election under Section 85 and agree on a "proceeds of disposition" amount, known as the elected amount.
• This elected amount can be between the adjusted cost base (ACB) and the fair market value (FMV) of the property.
• By setting the elected amount at the ACB, the taxpayer can defer any capital gain, essentially “rolling over” the gain until the corporation eventually disposes of the property.

Tax Implications:

• For the transferor: If the elected amount is set at the ACB, there is no immediate capital gain, so no taxes are due at the time of transfer. If the elected amount is higher than the ACB (but still below the FMV), a partial gain is triggered, allowing flexibility.
• For the corporation: The property’s ACB to the corporation becomes the elected amount. This forms the corporation’s base for calculating any future capital gains upon the eventual sale of the property.

Consideration Received:

• The taxpayer usually receives shares in the corporation, often in exchange for the elected amount, and can also receive “boot” (non-share consideration), such as cash or a promissory note.
• Receiving boot may trigger some capital gains if the boot exceeds the ACB of the property, though the gain can be limited based on the elected amount.

Example of a Section 85 Rollover

• Let’s say Sarah owns a piece of real estate (capital property) with an ACB of $200,000 and an FMV of $500,000. Sarah wants to transfer this property into her corporation.

1. Sarah and her corporation agree on an elected amount of $200,000 (the ACB), meaning no immediate capital gain is realized, and Sarah defers tax on the $300,000 appreciation.
2. In exchange, Sarah’s corporation issues her shares worth $500,000 (the FMV) and possibly some cash or a promissory note.
3. The corporation now has an ACB of $200,000 for the real estate, which will be used for calculating capital gains if it later disposes of the property.

Why Use a Section 85 Rollover?

• This rollover is beneficial for individuals who want to incorporate their business, transfer property into a corporate structure, or conduct an estate freeze without triggering immediate tax on unrealized capital gains. Section 85 rollovers help ensure that tax is deferred until a more favorable time, often when the property is ultimately sold or transferred out of the corporation.

Please contact our office so we can guide you through the intricacies of this complicated procedure.