Section 85 rollover: elect between tax cost and FMV, file a T2057

What elected amount can your client pick under section 85?

Your client can pick any amount from the higher of the boot and the property's tax cost floor up to its FMV. Under subsection 85(1), your client and the corporation jointly elect that amount for each property, and it becomes your client's proceeds of disposition and the corporation's cost laws-lois.justice.gc.ca. The Act overrides any number outside these limits.

So the usable range runs from the higher of the boot and the tax cost floor up to FMV. Elect at the floor and your client reports no income. Elect higher to use losses, a capital gains exemption or a CCA balance on purpose. Boot is anything your client takes back other than shares, usually a promissory note.

When several depreciable properties go across together, 85(1)(e.1) treats them as sold one at a time in the order your client designates, or in the order the Minister picks if you don't designate one laws-lois.justice.gc.ca.

Watch two numbers before you pick an amount. The T2057 is due on the earliest filing date of any party to the election, which is often the new corporation's first T2 when its first year is short, not your client's June 15 T1. A late election costs the lesser of 1/4 of 1% of the FMV excess and $100 for each month late, capped at $8,000 under 85(8) laws-lois.justice.gc.ca. Both are worked through in the deadline section below.

How does a sole proprietorship roll into a corporation without tax?

Elect each asset at its tax floor and take back boot equal to that floor, and your client reports no income while the whole deferred gain moves into the new shares laws-lois.justice.gc.ca.

Your client runs a profitable sole proprietorship and incorporates it. The corporation takes the inventory, the equipment (the only Class 8 asset, capital cost $60,000) and goodwill your client built up, with no Class 14.1 balance. It pays with a $65,000 promissory note and preferred shares worth $160,000.

Each elected amount sits at the floor and equals the boot allocated to that asset, so your client reports no income: proceeds of $35,000 on the equipment exactly match the $35,000 UCC, so there's no recapture. Elect the equipment at $45,000 instead and your client reports $10,000 of recapture.

The corporation's capital cost of the equipment stays at your client's $60,000 under 85(5), with the $25,000 difference treated as CCA already claimed laws-lois.justice.gc.ca. The recapture exposure moves into the corporation instead of disappearing.

On your client's side, the note has a cost equal to its $65,000 FMV under 85(1)(f). The preferred shares take the lesser of their FMV and the elected amount minus the boot under 85(1)(g): $65,000 minus $65,000, so the shares have an ACB of $0. The whole $160,000 deferred gain now sits in those shares.

The PUC grind under 85(2.1) follows. If the corporation adds the full $160,000 to the stated capital of the preferred shares, 85(2.1) cuts their paid up capital by (A minus B) × C/A laws-lois.justice.gc.ca. A is the PUC increase on all shares, B is the corporation's cost of the property minus the FMV of the boot, and C is the PUC increase on the class in question.

The grind stops your client pulling the $160,000 back out as a tax free return of capital when no tax was paid on the gain. PUC ends up equal to the elected amount minus the boot, which here is nil.

What property qualifies for a section 85 rollover?

Most capital property, inventory other than real property, Canadian and foreign resource property and a NISA Fund No. 2 qualify, as long as the buyer is a taxable Canadian corporation and the consideration includes shares of its capital stock laws-lois.justice.gc.ca. The CRA's circular says at least one share, or a fraction of one, is enough, and that without it the election is invalid canada.ca.

The eligible property list in 85(1.1) covers a NISA Fund No. 2 only when an individual owns it. Two exclusions catch people:

A partnership can roll property in too. Under 85(2), the corporation and all the partners elect jointly, on Form T2058 instead of T2057 canada.ca.

What else is a section 85 rollover used for besides incorporating?

The same election is used to freeze the value of a company, to crystallize the lifetime capital gains exemption, and to put a holding company over an operating company before a sale. Section 85 doesn't name any of these uses; each one relies on the elected amount rules above, and each runs into its own rule elsewhere in the Act.

On a freeze, 74.4(2) deems your client to receive interest at the prescribed rate on the outstanding amount of the transfer, less interest and certain dividends your client actually receives, for any year the conditions are met laws-lois.justice.gc.ca. The benefit rule and the price adjustment clause covered below protect the freeze value itself.

On a crystallization, the deduction under 110.6(2.1) applies to a share that was a qualified small business corporation share at the time of disposition laws-lois.justice.gc.ca. The new shares then take a higher cost under 85(1)(g) or (h). The CRA's GAAR supplement IC88-2S1, dated July 13, 1990, describes this exact sale to a related corporation under 85(1) and says it wouldn't be an abuse canada.ca. That view predates the economic substance rule and the penalty now in s.245, so test it against the current text laws-lois.justice.gc.ca. For the 2026 limit and the share tests, see lifetime capital gains exemption 2026.

Boot is where both of the last two uses go wrong. When an individual sells shares to a corporation they don't deal with at arm's length and the corporation whose shares were sold is connected with the buyer afterward, 84.1 can grind the PUC of the new shares and deem a dividend, and for that test it strips out of the old shares' cost any gain sheltered by the capital gains deduction laws-lois.justice.gc.ca. Under a holding company, an intercorporate dividend above safe income that cuts the gain on a later sale is treated as a capital gain under 55(2) laws-lois.justice.gc.ca.

When is the T2057 due, and what does filing late cost?

Under 85(6), the T2057 is due on the earliest date any party to the election has to file a return for the year of the transfer, and filing late costs up to $100 a month to a maximum of $8,000 laws-lois.justice.gc.ca. Form T2057 is the joint election for a taxpayer and a corporation under 85(1) canada.ca. It's filed separately from the income tax return, and each property needs its own elected amount canada.ca.

The trap is the corporation's short first year. A proprietor who carried on business has until June 15 to file the T1 laws-lois.justice.gc.ca. A corporation files within six months after its year end. Roll a business in on March 1, 2026 to a corporation with a September 30, 2026 year end, and the T2 is due March 31, 2027, which beats the June 15, 2027 T1. See T2 filing deadline and self employed tax deadline.

A missed deadline isn't fatal. Under 85(7), a late election still counts if it's filed within three years after the deadline and the estimated penalty is paid with it. After three years, 85(7.1) lets the Minister accept it only if that would be just and equitable laws-lois.justice.gc.ca.

The 85(8) penalty is the lesser of two amounts, per month or part of a month from the deadline to the filing date: 1/4 of 1% of the excess of the property's FMV over the elected amount, or $100. The $100 track is capped at $8,000, which it reaches at 80 months laws-lois.justice.gc.ca.

When does the benefit rule raise the elected amount?

The benefit rule raises the elected amount when your client gives up more value than they get back and part of the gap is a benefit to a related person; a price adjustment clause is the usual protection. Paragraph 85(1)(e.2) applies when the property's FMV exceeds the greater of the FMV of everything your client got back and the elected amount, and it's reasonable to regard part of that excess as a benefit your client wanted to confer on a related person laws-lois.justice.gc.ca. The elected amount is then increased by the benefit. It doesn't apply when the related person is a corporation your client wholly owns right after the transfer.

Say your client's spouse holds the common shares, and in the example above your client takes the $65,000 note but preferred shares worth only $100,000. The $60,000 shortfall went to the spouse through the common shares. The elected amounts rise by $60,000, so your client reports up to $60,000 of gain or recapture for nothing. The share cost rules in 85(1)(g) and (h) ignore that increase, so the same value can be taxed again later.

The usual protection is a price adjustment clause that resets the price if the CRA or a court finds a different FMV. The CRA recognizes one when the parties intended a sale at FMV, used a fair and reasonable valuation method, agree to use the CRA or court value, and actually refund or pay the difference or adjust the liability canada.ca.

The clause doesn't change the T2057 on its own. The CRA's circular says triggering it needs an amended election under 85(7.1), and the clause has to adjust both the price of the property and the consideration received canada.ca.