Section 85 Rollover: How to Avoid Tax on Capital Gains
Updated: Jun 12
A Section 85 rollover is an election in the Income Tax Act (the "ITA") that business owners can file to transfer eligible property (typically business assets) into a corporation. This rollover election allows a taxpayer to defer all or part of the tax consequences that would normally arise on the transfer, depending on their objectives. Section 85 enables the transferor and a transferee corporation to jointly elect to fix an "agreed amount" that both parties will use for tax purposes when transferring the property. This provision is particularly useful when the value of the property exceeds its tax cost, and the parties wish to postpone the recognition of any income or gain that would otherwise be realized on the transfer.
When transferring assets through a s. 85 rollover, the Canada Revenue Agency requires that you have made a “fair and reasonable” attempt to determine the fair market value of the shares or assets transferred. The transferor corporation will use the value of the shares it receives to determine the proceeds of disposition for the property transferred, which will be used to calculate any capital gains or losses that arise from the transfer. If the CRA discovers that the valuation used in a s. 85 asset/share transfer agreement was inaccurate, having a "price adjustment clause" in the agreement of purchase and sale is crucial. This clause essentially permits both parties to redo the transaction using the CRA-approved valuation. When drafting a price adjustment clause, it is essential to ensure that it allows for both an increase and a decrease in price, as well as the option for the parties to decide not to make the tax election and transfer the assets without the benefit of the rollover.
The section 85 rollover is commonly used in the following situations:
Sole proprietors who are looking to incorporate their business
Capital gains crystallization*
*When someone buys a capital asset, such as real estate, an increase or decrease in the value of the property does not translate to a profit or loss. The person can only claim a profit or loss after they have sold the property. Selling the property at a profit is referred to as crystallizing a capital gain.
Transfer of assets from one business to another or from a shareholder to a business
When the property is transferred to the corporation, any capital gains from the sale of the property can be offset by the company's losses during that financial year lowering a person's tax burden.
To qualify for the section 85 rollover, there must be an eligible transferor and transferee. An eligible transferor is defined in the ITA as any taxpayer, including individuals, corporations, and trusts. An eligible transferee must be a taxable Canadian corporation. The property being transferred can include both tangible, such as real estate and equipment, and intangible assets such as patents, trademarks, and goodwill.
To complete the title transfer registration, you need a real estate lawyer to assist you. The lawyer will also discuss with you how to avoid paying land transfer tax on the transfer, which may be preferrable (or not) depending on the particular transaction.
Overall, the section 85 rollover can be a useful tool for business owners looking to transfer assets on a tax-deferred basis. It is important to consult with a tax professional to ensure that all conditions are met and that the transaction is structured in a way that is most advantageous for both parties involved.
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