Section 85 Rollover
The Section 85 rollover is a provision within the Canadian Income Tax Act that enables a taxpayer to transfer eligible assets to a taxable Canadian corporation on a tax-deferred basis. In essence, this election allows the taxpayer to delay the tax implications that would typically arise from such a transfer, depending on their specific goals.
This Section 85 rollover is commonly utilized in various scenarios, including but not limited to:
Sole proprietors seeking to incorporate their business.
Estate planning purposes.
Realizing capital gains.
Transferring assets between different businesses.
Qualification Requirements:
To be eligible for the Section 85 rollover, certain conditions must be met:
Eligible Transferor and Transferee: The transferor can be any taxpayer, including individuals, corporations, and trusts, while the transferee must be a taxable Canadian corporation, typically incorporated in Canada.
Eligible Property: The property being transferred must fall within specific categories, such as depreciable and non-depreciable capital property, inventories (except for real property held as inventory), Canadian/foreign resource property, and real estate owned by non-residents used for business in Canada.
Consideration: The transferor must receive shares of the transferee as part of the consideration. Non-share consideration, known as "boot," may also be received, but its fair market value cannot exceed the tax cost of the property transferred.
How It Operates:
To initiate a Section 85 rollover, the transferor and transferee must agree upon the elected amount for the transfer, representing the transferor's proceeds of disposition and the transferee's cost of the acquired property. The elected amount cannot be less than the fair market value of the boot or greater than the fair market value of the property being transferred.
Depending on the type of property transferred, the lower range of the elected amount cannot be less than the lesser of the fair market value of the property and either the tax cost or adjusted cost base of the property.
In most cases, electing at tax cost or adjusted cost base results in a tax-free rollover. However, there may be instances where electing at a higher amount is considered to intentionally trigger gains, such as for utilizing loss carryforwards or capital gains exemption.
Scenarios:
As an example, if you wish to transfer non-depreciable capital property from your sole proprietorship to your newly incorporated Canadian company in exchange for common shares, the property's adjusted cost base is $100,000, and its fair market value is $300,000:
Without a Section 85 rollover, reporting the transfer at fair market value would result in a capital gain of $200,000 on your personal tax return.
With a Section 85 rollover, transferring the property at its adjusted cost base of $100,000 would lead to no immediate capital gain or tax consequences. The corporation's common shares would have an adjusted cost base of $100,000.
It's essential to note that the Section 85 rollover defers, rather than exempts, tax on the accrued gain, with the tax obligation postponed until the eventual sale of the capital property in the future.
Filing Requirements:
To execute this joint election, Form T2057 must be submitted to the CRA. This form should be filed by the earlier of the income tax return filing deadline for either the transferor or transferee for the taxation year in which the transfer occurred. If multiple transferors are involved in the same property transaction, a designated transferor can file all election forms on their behalf, along with a list of the involved transferors.
Late filing of the form is acceptable within three years from the original due date, provided an estimated penalty payment is included. Beyond this period, written justification is required, and acceptance of the late filing is at the discretion of the CRA.
If you are considering transferring capital property to a corporation, please contact us.