The transfer is made by means of a “section 85 election”, which is filed with your tax return and the corporation’s tax return (see also “Time for election”, below). The election allows a complete rollover (no immediate gain), or partial rollover (some immediate gain), depending on the “elected amount” on the transfer. The election is actually a joint election, in that it is made by you and the corporation. The election is made on Form T2057.
In order to qualify for the election, as consideration for the transfer of the property you must receive at least one share in the corporation. You may also receive non-share consideration – often called “boot” – but the boot may affect your elected amount in the manner discussed below.
Property that qualifies for the rollover includes capital property, and inventory other than real property.
Result of elected amount
The elected amount becomes your proceeds of disposition of the property transferred to the corporation. Therefore, for example, if you elect at your cost of the property, you will have a nil gain and nil income inclusion from selling the property to the corporation.
The elected amount also becomes the corporation’s cost of the property.
Lastly, the elected amount, net of any boot taken back, becomes the cost of your shares received as consideration.
Limits on the elected amount
There are three general limits to the elected amount.
- The elected amount cannot exceed the fair market value (“FMV”) of the property;
- The elected amount cannot be less than the lesser of the FMV of the property and its tax cost; and
- Subject to the first limit above, the elected amount cannot be less than the FMV of any boot.
Section 85 of the Income Tax Act (the “Act”) allows you to transfer property to a Canadian corporation without immediate tax consequences. The transfer is often called a “rollover”, because it can take place at the cost of the property, thereby avoiding the immediate recognition of accrued gains.
You transfer real property (a capital property) to your corporation. Your cost of the property was $200,000 and its FMV at the time of the transfer is $500,000. As consideration for the transfer, you receive 100 common shares in the corporation.
Assuming you elect at $200,000, there will be no gain on the transfer. The corporation’s cost of the property will be $200,000, and the cost of your 100 common shares will be $200,000.
Note that the rollover is essentially a deferral of tax rather than a complete exemption from tax, and can even create double tax down the road. If you subsequently sell your 100 common shares for more than your $200,000 original cost, you will have a capital gain at that point in time. Similarly, if the corporation sells the real property for more than $200,000, it will have a capital gain.
Assume the same facts as in Example 1, except that the consideration you receive is 100 common shares in the corporation plus $220,000 cash (the cash is boot). In this case, you cannot elect at an amount less than the $220,000 boot.
Assuming you elect at $220,000, you will have a $20,000 capital gain and half of that will be included in your income as a taxable capital gain. The corporation’s cost of the property will be $220,000. The cost of your 100 common shares will be $220,000 minus the $200,000 boot, or $20,000.
Electing for partial or no rollover
In most cases, if possible, you would elect at your tax cost of the transferred property. As noted, this would allow a tax-free rollover on the transfer.
However, in some cases you may want to deliberately trigger some or all of the accrued gain in respect of the property by electing at an amount greater than your tax cost.
For example, you may have current or previous capital losses than could offset any triggered gain. By electing an amount greater than your tax cost of the property, the gain would not be taxable if it were offset by your losses; and the result is that the corporation’s cost of the property and your cost of the shares taken back would be increased accordingly, leading to lower taxable capital gains somewhere down the road.
As another example, you may have transferred property that qualifies for the capital gains exemption – that is, qualified small business corporation shares or qualified farm or fishing property. Assuming you have a sufficient capital gains exemption available, you can elect to trigger a gain on the transfer of the property to the corporation, and again the greater elected amount means a greater cost of the property for the corporation and a greater cost of your shares taken back, leading to eventual lower taxable capital gains.
Unfortunately, you cannot trigger a loss on the transfer if you and the corporation are “affiliated”. In such case, any loss will be a superficial loss and therefore denied. The concept of “affiliated persons” is quite complex, but as an example, you are affiliated with the corporation if you or your spouse or common-law partner controls the corporation.
Time for election
The election must be filed by the earlier of your tax return due date and that of the corporation for the taxation year in which the transfer took place. Late filing within three years of that day is allowed, subject to a penalty. After the three years, you may be able to file late if the Canada Revenue Agency (CRA) is of the opinion that it would be “just and equitable” to allow the late filing. Again, a penalty will apply.