Section 85 rollover allows a Canadian taxpayer to transfer eligible property, deferring the tax to a taxable Canadian corporation. This means a taxpayer can defer part or all of the tax consequences that typically arise on the transfer, depending on objectives. Section 85 rollover applies to the following situations (and more):
- Estate planning
- Sole proprietors wanting to incorporate their business
- Transfer of assets from a business to another business
- Capital gains crystallization
Definition of Property
Income Tax Act subsection 248(1) defines "property" means property of any kind whatever whether real or personal, immovable, or movable, tangible, or intangible, or corporeal or incorporeal and, without restricting the generality of the foregoing, includes
- a right of any kind whatever, a share or a chose in action,
- unless a contrary intention is evident, money,
- a timber resource property,
- the work in progress of a business that is a profession; and
- the goodwill of a business, as referred to in subsection 13(34)
Qualifications for Section 85 Rollover
There must be an eligible transferee and transferor to qualify. An eligible transferee is a taxable Canadian corporation. An eligible transferor is any taxpayer, whether an individual, trust or corporation (typically incorporated in Canada).
The property must be eligible, which includes the following:
- Inventories, except for real property
- Depreciable and non-depreciable capital property
- Real estate owned by non-residents but used for business in Canada
- Canadian or foreign resource property
The transferor receives consideration on the transfer that includes transferee shares and might also receive the 'boot,' which is the name given to non-share consideration. The boot's fair market value must be less than the transferred property's tax cost. If not, it would trigger capital gains.
Non-share considerations might include a note receivable or cash, for example, and the fair market value of the transferred assets must be the same as the total consideration value.
How Section 85 Works
Once the transferor and transferee agree on the transfer amount, section 85 can be executed. The transfer amount is the proceeds of disposition from the transferor and the cost of the property acquired by the transferee. This amount can't be less than the fair market value or the boot or more than the fair market value of the property being transferred.
When transferring non-depreciable capital property or inventories, the lower range of the amount can't be less than whichever is lower out of the fair market value of the property and inventory tax cost or the adjusted cost base.
With a depreciable property transfer, the lower range of the amount must be more than whichever is lower: the property's fair market value, the adjusted cost base and the undepreciated capital cost.
Usually, you'd either tax cost or adjusted cost base for a tax-free rollover. However, there are scenarios where you might prefer to choose a higher amount to trigger gains, such as crystallizing the capital gains exemption or utilizing loss carry-forwards.
A Section 85 Example
Let's say you want to transfer non-depreciable capital property from a sole proprietorship you have into a newly incorporated Canadian company for the common shares. This property has a fair market value of $300,000 and an adjusted cost base of $100,000.
If you choose not to use section 85, you'd have to report a capital property disposition at the fair market value, resulting in a capital gain of $300,000 - $100,000, which is $200,000, on your tax return.
If you choose to use section 85, you can transfer it at the $100,000 adjusted cost base. There wouldn't be capital gain and, therefore, no immediate tax consequences. If there is no boot to consider, the adjusted cost base will be $100,000.
This means the tax related to the capital gain is deferred until the property is sold in the future. It doesn't mean the transferor is exempt from tax on the gain.
Filing Specifications
Form T2057 must be used to file for section 85, and it's due for the taxation year when the transfer took place. If there is more than one transferor involved, one of them can file all the forms on behalf of them all.
If this form is filed within 3 years of the due date, the CRA will accept a late filing. If it's filed after the 3 years, the taxpayer must justify the reason, and the CRA will decide whether to accept the late-filed election or not.
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