Here’s a simple example of a Section 85 rollover under the Income Tax Act of Canada, showing how it works and why it’s beneficial:
🧾 Scenario: Incorporating a Sole Proprietorship
Background
Ryan owns a small business as a sole proprietor. He wants to incorporate to limit liability and access corporate tax benefits. His business has:
Equipment worth $100,000 (original cost: $60,000)
Inventory worth $50,000
Goodwill valued at $150,000
If Ryan sells these assets to his new corporation at fair market value (FMV), he would trigger capital gains and income tax. Instead, he uses a Section 85 rollover.
🔁 Section 85 Rollover Steps
1. Transfer Assets to Corporation
Ryan transfers the equipment, inventory, and goodwill to RyanCo Inc., a newly formed Canadian-controlled private corporation (CCPC).
2. Elect Transfer Value
Ryan and RyanCo Inc. jointly elect a transfer value (called the "elected amount") for each asset:
Equipment: elected at $60,000 (original cost)
Inventory: elected at $50,000 (FMV, taxed as income)
Goodwill: elected at $60,000 (original cost)
3. Receive Shares in Exchange
Ryan receives common shares of RyanCo Inc. worth $210,000 (total FMV of assets), but only $170,000 is elected for tax purposes.
4. File T2057 Form
Ryan and RyanCo Inc. file a T2057 election form with CRA to document the rollover.
✅ Benefits
Defers capital gains tax on equipment and goodwill.
Avoids immediate tax hit, preserving cash flow.
Ryan now owns shares in a corporation, which can be used for estate planning, income splitting, or future sale.
⚠️ Costs and Considerations
Inventory is taxed as income, even under rollover.
Legal and accounting fees for valuation and documentation.
Future tax liability when shares are sold or assets are disposed.
Must comply with CRA rules to avoid penalties.
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