Section 85 Rollovers & Section 86 Share Exchanges
Tax-Deferred Corporate Reorganizations for Business Owners in Canada
At Kalfa Law we help business owners, entrepreneurs, and corporations restructure their organizations in the most tax-efficient way possible. Two of the most powerful tools under the Canadian Income Tax Act for deferring tax during a reorganization are the Section 85 rollover and the Section 86 share exchange.
These transactions allow you to transfer assets or exchange shares without triggering immediate capital gains when structured correctly.
Section 85 Rollover
What Is a Section 85 Rollover?
A Section 85 rollover is a tax-deferred corporate transaction that allows a taxpayer (the transferor) to transfer eligible property, such as capital assets, inventory, real estate, goodwill, or shares, to a Canadian corporation (the transferee) without triggering immediate capital gains tax.
Instead of an outright taxable disposition, the transferor receives shares of the corporation in exchange for the property. This rollover is commonly used when business owners want to move assets into a corporate structure while delaying capital gains until a later time.
How Tax Deferral Works
The core benefit of a Section 85 rollover is the ability to choose an elected amount, which becomes the transferor’s proceeds of disposition and the corporation’s cost of the transferred property.
This elected amount must fall between the property’s ACB (Adjusted Cost Base) and FMV (Fair Market Value).
- Electing an amount close to the ACB → avoids immediate tax
- Electing an amount above the ACB → triggers partial tax now but may simplify future planning
In many cases, a promissory note (“boot”) is used to allow the transferor to extract the cost basis tax-free, while the corporation assumes a lower tax cost, deferring gains until the asset is eventually sold to a third party.
Required Filing
Both the transferor and the corporation must file CRA Form T2057 to report the Section 85 rollover.
When Section 85 Rollovers Are Commonly Used
1. Incorporating a Sole Proprietorship
If an individual simply begins running their business through a corporation, they may inadvertently trigger capital gains tax. A Section 85 rollover allows for tax-free transfer of the sole proprietorship assets into a new corporation.
2. Creating an Opco–Holdco Structure
If a shareholder wants to transfer shares of an operating company (opco) into a holding company (holdco), this triggers capital gains. A Section 85 rollover neutralizes the tax and allows the shareholder to layer in a holding company for asset protection or tax planning.
3. Transferring Real Estate into a Corporation
Owners may want to house real property inside a corporation for tax or liability reasons. A Section 85 rollover can defer capital gains, but cannot defer provincial Land Transfer Tax, which applies independently.
Limitations & Considerations
While Section 85 rollovers offer excellent tax-deferral benefits, they must be carefully structured due to:
- anti-avoidance rules
- restrictions on eligible property
- potential future recapture
- complicated elections for ACB, FMV, boot, and share consideration
- required valuation support
Because every situation is unique, business owners should seek legal guidance to avoid unintended tax consequences.
Section 86 Share Exchange
What Is a Section 86 Share Exchange?
A Section 86 share exchange is a tax-deferred reorganization that allows a shareholder to exchange one class of shares for another class within the same corporation without triggering immediate tax.
Under this provision of the Income Tax Act, a shareholder can swap shares (often common shares) for newly issued shares (often fixed-value preferred shares).
The capital gain is deferred until the new shares are ultimately disposed of.
How It Works
The shareholder disposes of all shares of a particular class. The corporation issues new shares in exchange. Note that no formal election is required; the rollover applies automatically provided the appropriate language is reflected in the capital reorganization agreement. The ACB and FMV of the old shares carry over to the new shares and the exchange must qualify as a share reorganization under the Income Tax Act.
This type of reorganization is most commonly used in estate and succession planning.
When Section 86 Share Exchanges Are Used
Estate Freezes
A Section 86 share exchange is a key tool for estate freezes, where the current owner:
- converts their common shares into fixed-value preferred shares
- locks in the current value of the company
- issues new common shares (with future growth) to children or family trusts
This allows future business growth to accrue to the next generation while deferring capital gains for the current owner.
Corporate Reorganization
Section 86 is used to reorganize share capital. For example:
- converting voting shares into non-voting
- restructuring classes of shares for investor entry
- simplifying share structures without triggering tax
Section 85 vs Section 86: Which One Do You Need?
|
Scenario |
Appropriate Section |
|
Transferring property into a corporation |
Section 85 |
|
Moving your business from sole proprietorship to corporation |
Section 85 |
|
Setting up a holding company |
Section 85 |
|
Freezing business value for children |
Section 86 |
|
Reclassifying share capital |
Section 86 |
|
Internal corporate reorganizations |
Section 86 |
Kalfa Law Firm evaluates your structure, goals, and tax implications to determine which section, or combination, best suits your situation. Learn more about our Corporate Structuring services
Why Work With Kalfa Law Firm?
- Experienced corporate lawyers with deep tax-planning expertise
- Full guidance on valuations, share structures, and elected amounts
- Legal preparation of all documents, including T2057 filings
- Coordination with accountants and tax advisors
- Compliance with CRA requirements and corporate law
- Strategic long-term business and succession planning
Whether you’re incorporating, reorganizing, or freezing your estate, our lawyers provide tailored advice to ensure your transaction is compliant, efficient, and aligned with your goals.
Start Your Corporate Reorganization With Confidence
Considering a Section 85 rollover or Section 86 share exchange?
Our corporate commercial lawyers can help you determine the best structure for your business and ensure a smooth, compliant transaction.
Contact Kalfa Law Firm today to schedule a consultation.
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