The Income Tax Act and a Section 85 Rollover: Transfer of Property to a Corporation

Written by Fahad Malik
JD Candidate 2025 | UCalgary Law

Entrepreneurs can often begin their ventures as sole proprietors or partnerships due to simplicity and lower initial costs. However, as businesses expand, incorporating can offer benefits such as limited liability and potential tax advantages. It is usually the natural course of action an entrepreneur will take. A key tax planning tool in this transition is the Section 85 rollover. It is a provision in the Income Tax Act (“ITA”) that allows for tax-deferred transfers of assets to a corporation. Section 85 in the ITA is one of the tools entrepreneurs can use to ensure effective tax planning for their business.
 
Understanding a Section 85 Rollover
Section 85 enables business owners to transfer eligible property like equipment, real estate, or goodwill to a taxable Canadian corporation without triggering immediate tax liabilities.[1] This deferral is achieved by electing an "elected amount," which is typically set between the property's original cost and its fair market value (“FMV”).[2] By doing so, entrepreneurs can postpone recognizing capital gains until the corporation eventually disposes of the assets.
Under Section 85 of the ITA, eligible property that can be transferred to a taxable Canadian corporation on a tax-deferred basis includes:[3]

• Depreciable Capital Property: Assets like buildings and equipment that lose value over time.
• Non-Depreciable Capital Property: Assets such as land and certain investments that do not depreciate.
• Inventory: Items held for sale or used in production.
• Canadian and Foreign Resource Properties: Assets related to natural resources.

However, certain assets are excluded from eligibility, including:

• Cash
• Prepaid Expenses
• Real Property Held as Inventory

 
 
Benefits for Entrepreneurs
Incorporating a Growing Business: As a sole proprietorship flourishes, incorporating can provide benefits like limited liability protection and enhanced credibility. However, directly transferring assets to the new corporation might result in immediate tax consequences due to capital gains that can be triggered. Utilizing a Section 85 rollover allows entrepreneurs to defer these taxes, facilitating a smoother transition to an incorporated entity.
Reorganizing Business Structures: Entrepreneurs may need to restructure their businesses for various reasons, such as bringing in new investors or segregating different business operations. A Section 85 rollover permits the transfer of assets between corporations without immediate tax implications, aiding in efficient reorganization.[4]
Succession Planning and Estate Freezes: For business owners planning to pass their enterprise to the next generation, a Section 85 rollover can be instrumental. By transferring assets to a corporation, owners can implement estate freezes, locking in the current value of the business for tax purposes and allowing future growth to accrue to successors, thereby minimizing potential tax liabilities upon death.[5]
 
Practical Examples
Incorporating a Sole Proprietorship: Jane operates a successful consulting business as a sole proprietor. Her business assets, including equipment and client contracts, have appreciated over time. By using a Section 85 rollover, Jane transfers these assets to a newly formed corporation without incurring immediate taxes on the appreciated value, allowing her to benefit from incorporation advantages seamlessly.
Business Reorganization: John owns a company that manufactures and distributes products. To attract investors specifically interested in the manufacturing segment, he decides to separate the manufacturing operations into a distinct corporation. Through a Section 85 rollover, John transfers the manufacturing assets to the new corporation without triggering immediate tax liabilities, making the investment opportunity more appealing.
Estate Planning: Jane wishes to pass her family-owned business to her children. By implementing an estate freeze using a Section 85 rollover, she transfers the business assets to a corporation in exchange for fixed-value preferred shares. Her children then subscribe to common shares, allowing future growth to accrue to them. This strategy helps in managing and potentially reducing the family's tax burden upon succession.
Conclusion
The ITA is filled with man tax planning tools and section 85 is a crucial tool to use at the beginning of an entrepreneur’s journey. Failing to be aware of it can lead to tax liabilities that the new business will have trouble handling. Depending on the property the tax burden can be huge!


[1] Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), Section 85.

[2] Ibid.

[3] Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), Section 85(1.1).

[4] Wright, Nicholas dePencier. "S. 85 Rollovers under the Income Tax Act (Canada)." Wright Business Law, November 19, 2024. https://wrightbusinesslaw.ca/s-85-rollovers-under-the-income-tax-act-canada/.

[5] Ibid.