Section 85 Rollover Under the Income Tax Act: How It Works for Canadian Corporations

Transferring assets into your corporation — equipment, a vehicle, commercial property, or investments — comes with a tax trap most business owners don't see coming. Under the default rules of the Canadian Income Tax Act (ITA), any transfer of property to a corporation is treated as a disposition at fair market value. If those assets have appreciated since you acquired them, you trigger an immediate capital gain — sometimes thousands of dollars in tax — before your corporation has generated a single dollar from those assets.

Section 85 of the ITA exists to solve this problem. It allows you to transfer eligible property to a taxable Canadian corporation on a tax-deferred basis. The tax isn't forgiven — it's deferred until you eventually sell your shares or the corporation disposes of the assets.

That said, a section 85 rollover is one of the more technically demanding transactions in Canadian corporate tax law. The agreed amount, the consideration structure, and the Form T2057 filing deadline all leave little room for error. If you're planning a rollover, speaking with a qualified tax professional before proceeding is strongly recommended.

What Is a Section 85 Rollover?

A section 85 rollover is a tax deferral mechanism under subsection 85(1) of the Income Tax Act that allows a Canadian taxpayer to transfer eligible property to a taxable Canadian corporation without recognizing an immediate capital gain. In exchange, the transferor must receive at least one share of the corporation. The transfer is made at an agreed amount — a price set jointly by the transferor and the corporation — which can be set as low as the property's cost base rather than its fair market value (FMV). This is what makes the tax deferral possible: by setting the agreed amount at cost, no gain arises at the time of transfer.

The tax doesn't disappear. The accrued gain is preserved in the cost base of the shares you receive and in the corporation's cost of the transferred assets. It will surface when you eventually sell your shares or when the corporation disposes of those assets.

This mechanism is most commonly used in three situations:

• When incorporating an existing sole proprietorship or partnership, to transfer business assets to the new corporation without triggering immediate tax.
• When restructuring between related parties, such as transferring assets within a family-owned corporate group.
• When creating or funding a holding company to hold business assets or investments on a tax-deferred basis.

How the Agreed Amount Works

The agreed amount is the cornerstone of any section 85 rollover. It determines your proceeds of disposition, the corporation's cost of the transferred property, and the cost base of the shares you receive in return.

The ITA sets a specific range within which the agreed amount must fall:

• Floor: the higher of (a) the fair market value of any non-share consideration (boot) received, and (b) the tax cost of the property — the adjusted cost base (ACB) for non-depreciable capital property, or the undepreciated capital cost (UCC) for depreciable property.
• Ceiling: the fair market value of the property being transferred.

In practice, the agreed amount is typically set at the floor to maximize the tax deferral. Setting it at the property's cost base means no capital gain arises at the time of transfer.

Boot — any consideration other than shares, such as cash or a promissory note — is permitted, but it carries risk. If the boot exceeds the property's cost base, the excess is taxable immediately. Most rollovers are structured with minimal or no boot to preserve the full deferral.

When Is a Section 85 Rollover Used?

A section 85 rollover under the Income Tax Act applies in a range of corporate and personal planning situations:

• Incorporating a sole proprietorship: You've been operating as a self-employed professional or contractor and are now incorporating. Rather than triggering tax on the appreciated value of your business assets on day one, the rollover lets you transfer equipment, vehicles, and other eligible property to your new corporation at cost.
• Corporate reorganization: You're restructuring your corporate group — for example, transferring assets or shares between related entities — and want to do so without triggering unnecessary tax.
• Funding a holding company: You're transferring assets to a holding company (Holdco) for asset protection or tax planning purposes. In a family succession context, the rollover is often used alongside an estate freeze to lock in the current owner's value and transfer future growth to the next generation.

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Section 85 Rollover Examples

Rollover Between an Individual and Their Corporation

Mr. Yves owns a commercial lot he purchased for $100,000. It's now worth $200,000. Without a rollover, transferring it to his corporation would trigger a capital gain of $100,000, taxable in the year of transfer.

Under section 85, Mr. Yves sets the agreed amount at his adjusted cost base ($100,000) and receives shares of his corporation in exchange. No tax arises at the time of transfer. The gain is preserved in the cost base of his shares and will be recognized when he eventually sells them.

When the transferred property includes both a building and land, the two components must be treated as separate properties on Form T2057, each with its own agreed amount. For the building (depreciable property), the agreed amount is typically set at the undepreciated capital cost (UCC). For the land (non-depreciable capital property), it is set at the adjusted cost base (ACB). Treating them as a single property can inadvertently trigger a recapture of capital cost allowance (CCA) — a common and costly mistake.

Rollover Between Two Corporations

Corporation A wants to transfer business assets to Corporation B in exchange for shares. Without a rollover, the transfer would be treated as a disposition at fair market value, triggering immediate tax on any accrued gains. Under section 85, Corporation A sets the agreed amount at the cost base of the assets, receives shares of Corporation B in return, and defers the tax. Corporation A preserves its liquidity, and Corporation B takes ownership of the assets with an adjusted cost base equal to the agreed amount.

Section 85.1 of the ITA is a separate but related provision that applies specifically to share-for-share exchanges between arm's length Canadian corporations. Unlike subsection 85(1), section 85.1 applies automatically when the conditions are met — no joint election form or filing deadline is required. The two provisions serve different purposes and should not be confused.

Form T2057 — and Form TP-518 in Quebec

A section 85 rollover does not apply automatically. The transferor and the corporation must jointly file Form T2057 (Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation) with the CRA. The form must be signed by both parties and filed separately from any income tax return.

For Quebec taxpayers, Form TP-518 must also be filed with Revenu Québec. The agreed amounts on both forms must be identical. These two forms are entirely distinct from Form T2054, which deals with foreign affiliate elections and has no connection to a section 85 rollover.

Filing deadline: The deadline to file Form T2057 is the earliest of the T1 personal income tax return filing deadline of the transferor for the year of the transfer, and the T2 corporate tax return filing deadline of the corporation for the tax year that includes the transfer date.

A late election incurs a penalty of $25 per day (minimum $100, maximum $2,500). Under subsection 85(7), a late election can be filed up to three years after the original deadline. Beyond that, the CRA may still accept a late filing under subsection 85(7.1) if the circumstances are considered just and equitable — but this is discretionary and not guaranteed.

An invalid election is more serious: the CRA treats the transfer as having occurred at fair market value, and the full capital gain becomes immediately taxable, plus interest.

What Property Is Eligible?

Section 85 of the ITA specifies which property qualifies for the rollover. Not all assets can be transferred on a tax-deferred basis.

Eligible property includes capital property held by a Canadian resident (equipment, vehicles, commercial real estate, land), depreciable property, inventory (excluding land held as inventory by real estate developers), shares of another corporation, Canadian and foreign resource property, and eligible capital property including goodwill.

Ineligible property includes cash, personal-use property, land held as inventory by developers, assets held in an RRSP, RRIF, or TFSA, and work in progress of certain self-employed professionals such as lawyers, physicians, and accountants.

If you're unsure whether a specific asset qualifies, confirming eligibility with a tax advisor before proceeding is essential — transferring ineligible property on a T2057 does not invalidate the rest of the election, but the CRA will disregard that property and treat it as disposed of at fair market value.

What Is the Difference Between a Section 85 and a Section 86 Rollover?

These two provisions are frequently confused but serve entirely different purposes.

A section 85 rollover applies when a taxpayer transfers eligible property — assets, shares, or other capital property — to a corporation in exchange for shares of that corporation. It requires a joint election (Form T2057) filed within the prescribed deadline. Section 85 takes priority: if subsection 85(1) or (2) applies to a transaction, section 86 cannot apply to the same transaction.

A section 86 rollover applies within a single corporation: it allows a shareholder to exchange all of their shares of a particular class for new shares of a different class of the same corporation, as part of a reorganization of the corporation's capital. No election form is required. Section 86 is commonly used for estate freezes and corporate restructurings where the goal is to change the share class structure without triggering an immediate capital gain.

In short: section 85 involves a transfer of property from a taxpayer to a corporation; section 86 involves a reclassification of shares within a corporation.

Why File Your T2 With T2inc.ca After a Section 85 Rollover?

A section 85 rollover is a powerful tax planning tool, but its effects carry through to your annual corporate tax filings. The agreed amounts, the cost base of transferred assets, and the shares issued in the exchange all need to be accurately reflected in your corporation's records and in its T2 corporate tax return. For Quebec corporations, the same applies to the CO-17 provincial return. Once your rollover has been completed with the help of your tax advisor, T2inc.ca handles your corporate return — accurately and efficiently.

FAQ — Section 85 Rollover

What is a section 85 rollover?

A section 85 rollover is a tax deferral mechanism under subsection 85(1) of Canada's Income Tax Act that allows a taxpayer to transfer eligible property to a taxable Canadian corporation without triggering an immediate capital gain. The transfer is made at an agreed amount — typically set at the property's cost base — and the transferor receives at least one share of the corporation in exchange. The tax on any accrued gain is deferred until the future disposition of those shares or assets. Form T2057 must be jointly filed with the CRA, and Form TP-518 with Revenu Québec for Quebec taxpayers.

Does a section 85 rollover eliminate the capital gains tax?

No. It defers it. The accrued gain is embedded in the cost base of the shares you receive and in the corporation's cost of the transferred assets. It will be recognized — and taxed — upon a future disposition, such as when you sell your shares.

What is the time limit for a section 85 rollover?

The deadline to file Form T2057 is the earliest of your personal T1 filing deadline and the corporation's T2 filing deadline for the year that includes the transfer date. A late election can be filed up to three years after that deadline, subject to a penalty of $25 per day (minimum $100, maximum $2,500). Beyond three years, acceptance is at the CRA's discretion under subsection 85(7.1).

Is Form T2057 mandatory?

Yes. Without a valid, jointly signed Form T2057, the CRA does not recognize the rollover election. Quebec taxpayers must also file Form TP-518 with Revenu Québec, with identical agreed amounts on both forms.

What is the difference between a section 85 and a section 86 rollover?

A section 85 rollover involves the transfer of eligible property (assets, shares) from a taxpayer to a corporation, in exchange for shares of that corporation. It requires a joint election filed on Form T2057. A section 86 rollover involves the exchange of shares within a single corporation — a shareholder swaps all of their shares of one class for shares of a different class of the same corporation, as part of a capital reorganization. No election form is required for section 86, and it does not apply when section 85 already applies to the transaction.

Can I complete a section 85 rollover without professional help?

It is strongly discouraged. Errors in the agreed amount, the consideration structure, or the filing deadline can result in the full capital gain becoming immediately taxable, plus interest and penalties. Given the complexity of the rules and the amounts typically involved, working with a qualified CPA or tax lawyer is essential.

This article is for informational purposes only and does not constitute tax or legal advice. Every situation is unique — consult a qualified CPA before making any tax-related decisions.