For Canadian entrepreneurs, medical professionals, and growing business owners, the transition from an unincorporated sole proprietorship or general partnership into a Canadian-Controlled Private Corporation (CCPC) represents a pivotal milestone in wealth accumulation. Incorporating provides access to the small business tax rate (9% to 12%), limited legal liability, and flexible remuneration planning. However, the physical act of transferring appreciated business assets—such as proprietary software, manufacturing machinery, customer contracts, commercial goodwill, or real estate—into a newly formed corporation carries a catastrophic hidden tax risk: under default rules of the Income Tax Act, transferring property to an affiliated corporation is treated as a deemed disposition at fair market value (FMV).
Without specialized statutory planning, an entrepreneur with $500,000 of accrued goodwill and $200,000 of appreciated equipment would trigger immediate, non-refundable capital gains taxes and depreciation recapture on their personal tax return—generating a tax bill of up to $200,000 before the new corporation has even opened its commercial bank account. To eliminate this barrier to corporate growth, Parliament enacted Section 85(1) of the Income Tax Act. Governed by a joint election filed via CRA Form T2057, a Section 85 rollover allows an owner to legally transfer appreciated assets into a corporation on a completely tax-deferred basis.
What Is a Section 85 Rollover in Canada?
A Section 85(1) rollover allows Canadian taxpayers to transfer eligible property into a corporation without triggering immediate capital gains or income tax. By electing an agreed transfer amount between the tax cost and fair market value, tax liability is deferred until the replacement corporate shares are eventually sold.
The operational mechanics of Section 85 center on the concept of the “Elected Amount” (also known as the agreed transfer price). Under Section 85(1), the transferor (the individual business owner) and the transferee (the new corporation) jointly elect a specific dollar figure that replaces fair market value as the deemed proceeds of disposition. By electing an amount equal to the transferor’s original Adjusted Cost Base (ACB) for non-depreciable capital property, or the Undepreciated Capital Cost (UCC) for depreciable machinery, the calculated capital gain on the personal tax ledger evaluates to exactly zero.
In exchange for the transferred property, the corporation must issue “consideration” that includes at least one share of the corporation’s capital stock. The corporation may also issue non-share consideration—frequently referred to as “boot”—such as an interest-free promissory note payable to the owner. This allows the business owner to extract tax-free cash from the corporation in subsequent years as the company repays the shareholder loan.
Eligible Property vs Ineligible Property Under Section 85
Not all commercial assets can participate in a Section 85 tax deferral. The Income Tax Act establishes rigid statutory guardrails distinguishing eligible assets from prohibited property:
| Asset Category | Section 85 Eligibility | Elected Amount Floor (ACB / UCC) | Boot (Non-Share Consideration) Limit | Forensic Tax Consideration |
|---|---|---|---|---|
| Commercial Goodwill | Fully Eligible (Capital Property) | $1.00 nominal floor (or historical ACB) | Limited to elected amount to avoid immediate gain | Requires formal valuation to prevent Section 85(1)(e.2) penalty |
| Depreciable Machinery / Equipment | Fully Eligible (Class 8, 10, 50) | Lesser of original cost and class UCC | Capped at class UCC to prevent CCA recapture | Transfers historical cost base to corporation for future CCA |
| Accounts Receivable | Eligible via Section 22 Election | Face value minus bad debt reserve | Full face value can be taken as promissory note | Section 22 joint election is simpler than Section 85 for AR |
| Real Property Inventory (Land Flipping) | Strictly Ineligible | N/A | N/A | Section 85(1.1) explicitly excludes real property held as inventory |
| Capital Real Estate (Rental Property) | Fully Eligible (Subject to land transfer tax) | Land ACB / Building UCC | Capped at debt assumed plus cash boot | Defers income tax but provincial Land Transfer Tax often applies |
A critical trap that ensnares unwary business owners involves the “Boot Ceiling.” Under Section 85(1)(b), the elected amount cannot be less than the fair market value of the non-share consideration (the boot) received by the transferor. If you transfer a business with an ACB of $50,000 and take back a shareholder promissory note of $150,000, your elected amount is automatically forced up to $150,000, immediately triggering a taxable capital gain of $100,000. To preserve complete tax deferral, non-share consideration must never exceed the tax cost base of the transferred property.
Statutory Guardrails: Form T2057 Deadlines and Valuation Penalties
Executing a Section 85 rollover requires strict compliance with administrative statutory deadlines established by the Canada Revenue Agency:
To legally formalize the rollover, both the individual transferor and the corporation must sign and file CRA Form T2057 (Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation). The statutory deadline is the earliest date on which either party’s corporate or personal tax return is due for the taxation year in which the transfer took place. If the election is filed late, the CRA imposes monthly late-filing penalties of $100 per month up to a maximum of $8,000 per election.
Furthermore, Section 85 rollover agreements must incorporate a contractual Price Adjustment Clause (PAC). Because valuing intangible commercial goodwill and private corporate assets is an inexact science, the CRA may audit the transaction and assign a higher fair market value to the transferred property. A properly drafted Price Adjustment Clause automatically adjusts the number or redemption value of the preference shares issued by the corporation if the CRA establishes a different valuation, preventing punitive tax penalties under Section 15(1) shareholder benefit rules.
Actionable Playbook: 4 Steps to Execute a Flawless Section 85 Transfer
- Commission an Independent Asset Valuation: Retain a Chartered Business Valuator (CBV) or qualified professional accountant to establish supportable fair market values for commercial goodwill, proprietary intellectual property, and equipment classes before executing transfer agreements.
- Structure Share Consideration with Retractable Preferred Shares: Issue fixed-value, redeemable, retractable preferred shares with a redemption amount equal to the difference between fair market value and the promissory note boot. This locks in the asset value without immediate tax.
- Draft a Comprehensive Section 85 Asset Purchase Agreement: Ensure your corporate solicitor embeds a robust Price Adjustment Clause, explicit allocation schedules matching asset classes, and formal corporate resolutions authorizing the issuance of consideration shares.
- Submit Form T2057 Before the Statutory Filing Cliff: Coordinate between your personal and corporate tax accountants to file Form T2057 alongside your annual T1 and T2 tax returns with electronic proof of transmission to eliminate late-filing penalties.
Once corporate share capital is structured via Section 85, extracting accumulated equity tax-efficiently is the next frontier. Review our complete guide to Capital Dividend Account in Canada: The CDA Guide.
People Also Ask
What is the main benefit of a Section 85 rollover in Canada?
The primary benefit is complete tax deferral. It allows business owners to transfer appreciated assets from a sole proprietorship, partnership, or holding company into a corporation without triggering immediate capital gains tax or depreciation recapture.
What is the deadline to file CRA Form T2057?
Form T2057 must be filed on or before the earliest date on which either the transferor’s personal tax return or the transferee corporation’s T2 return is due for the tax year in which the transfer occurred. Late filing incurs penalties up to $8,000.
Can real estate be transferred using a Section 85 rollover?
Capital real property (such as commercial buildings or rental properties) can be transferred under Section 85(1) to defer income taxes. However, real property held as inventory (such as land development stock) is strictly ineligible, and provincial Land Transfer Tax generally still applies on the title transfer.
Managing shareholder loan accounts is critical when planning corporate asset transfers and capital debt notes. Read our cornerstone guide to CRA Section 15(2) Rules: Shareholder Loan Tax Trap.