What Is a Section 85 Rollover and Can It Help When Selling My Business?
A section 85 rollover under ITA s. 85(1) allows you to transfer eligible property to a Canadian corporation at an elected amount that is below fair market value, deferring the capital gain that would otherwise arise on the transfer. When used strategically before a business sale, a section 85 rollover can restructure your corporate holdings to maximize Lifetime Capital Gains Exemption (LCGE) eligibility, multiply the LCGE across family members through an estate freeze, or move excess assets out of an operating company to satisfy the QSBC purification tests. It is one of the most powerful tools in the pre-sale tax planning toolkit and one of the most technically demanding to implement correctly.
What Is a Section 85 Rollover?
A section 85 rollover is a joint election between a transferor (an individual, trust, or corporation) and a Canadian corporation (the transferee) to transfer eligible property to the corporation at a chosen “elected amount” rather than at fair market value.
In a normal property transfer, the transferor disposes of the property at its fair market value, triggering any accrued gain at that point. A section 85 rollover allows the parties to elect a lower amount, so the gain is deferred rather than realized immediately.
The mechanics work as follows. The transferor disposes of the property at the elected amount, and if that amount equals the property’s adjusted cost base, no gain arises on the transfer. The transferee corporation acquires the property with a cost base equal to the elected amount, meaning the accrued gain is preserved inside the corporation rather than recognized at the time of transfer. The transferor receives consideration from the corporation, typically a combination of shares and a promissory note sometimes called “boot,” and the ACB of the shares received equals the elected amount less any non-share consideration received.
The section 85 rollover does not eliminate the gain. It defers the gain by rolling it into the shares of the transferee corporation or into the corporation’s cost base in the transferred property. When those shares are eventually sold, or when the corporation disposes of the property, the deferred gain is recognized.
The strategic value of the rollover is in what happens between the transfer and the eventual recognition: specifically, whether the shares received qualify for the LCGE, whether additional shareholders can access their own LCGE on those shares, and whether the corporate structure is better positioned for the ultimate sale.
What Property Is Eligible for a Section 85 Rollover?
Under ITA s. 85(1.1), eligible property for a section 85 rollover includes capital property such as shares of a corporation, real estate held as capital property rather than inventory, debt obligations, and other capital assets. This includes depreciable property across all CCA classes such as buildings, equipment, vehicles, as well as goodwill, customer lists, trademarks, and licenses, which are categorized under CCA Class 14.1 (which fully replaced the former Eligible Capital Property regime on January 1, 2017). Inventory of a business, meaning goods held for sale in the ordinary course but excluding real property inventory, is also eligible, as are Canadian and foreign resource property.
Property that is not eligible for a section 85 rollover includes real property held as inventory (for a developer or dealer); certain excluded property in specific contexts; and cash or near-cash instruments, which do not involve a transfer of property in the technical sense.
The most common properties transferred in a pre-sale Section 85 rollover are shares of the operating corporation (in an estate freeze or holding company reorganization), assets of an unincorporated business being incorporated, and specific assets being moved between related corporations as part of a purification.
How Is the Elected Amount Determined?
The elected amount is the amount at which the transfer is deemed to occur for tax purposes. The parties choose this amount within the following constraints:
Lower limit: The elected amount cannot be less than the lower of (a) the FMV of the property and (b) the cost amount of the property. In practical terms, this means the elected amount cannot be less than the property’s ACB (for capital property) or undepreciated capital cost (for depreciable property). This rule prevents the transferor from crystallizing an artificial loss on the transfer.
Upper limit: The elected amount cannot exceed the FMV of the property at the time of transfer. The parties cannot elect an amount higher than what the property is actually worth.
Within those two limits, the parties can elect any amount they choose. The most common strategy is to elect the cost amount (ACB or UCC) so that no gain arises on the transfer. This is the “nil gain” election, and it maximizes the deferral.
The boot trap
If the transferor receives non-share consideration (a promissory note, cash, or assumed debt) as part of the consideration for the transferred property, the elected amount is automatically bumped up to the amount of that boot if the boot exceeds the elected amount. This is the most common mechanical error in section 85 transactions.
For example, a taxpayer transfers property with an ACB of $100,000 and an FMV of $500,000 to a corporation, electing $100,000, but receives a $150,000 promissory note plus shares. The elected amount is automatically bumped to $150,000, triggering a $50,000 gain. The taxpayer did not intend to trigger a gain, but the boot in excess of the elected amount caused one.
The structuring implication: the promissory note in a Section 85 rollover should be set at or below the elected amount (the cost amount of the property), not at FMV. The remaining consideration between the elected amount and FMV is received in the form of shares of the transferee corporation. This is why section 85 transactions typically involve three components: a promissory note equal to the ACB (or less), preferred shares with a fixed redemption value equal to the FMV balance, and potentially common shares.
How a Section 85 Rollover Is Used Before a Business Sale
Use 1: Purification of the operating company
One of the most common pre-sale uses of a section 85 rollover is to move excess assets out of the operating company to satisfy the QSBC purification tests for LCGE eligibility.
To qualify as a Qualifying Small Business Corporation share, the 90% test requires that 90% or more of the FMV of the corporation’s assets be used in an active business at the time of sale. If a company has accumulated excess cash, investments, or other passive assets, those assets may cause the shares to fail the 90% test.
A section 85 rollover allows the operating company to transfer those excess assets to a holding company at elected amounts, removing them from the operating company’s balance sheet before the 90% test is applied. The operating company transfers the passive assets to a Holdco in exchange for shares of Holdco, electing an amount equal to the cost amount of each asset. The result: the operating company’s balance sheet consists of active business assets, the shares satisfy the 90% test, and the passive assets are now in the Holdco outside the QSBC calculation.
Use 2: Estate freeze with LCGE multiplication
An estate freeze is a reorganization that freezes the current owner’s equity in a fixed-value instrument (typically preferred shares) and allows future growth to accrue to new common shareholders, who may be family members or a family trust.
The section 85 rollover is the mechanism by which the freeze is implemented. The owner transfers their common shares of the operating company to a new holding corporation at an elected amount equal to the ACB of those shares, receiving fixed-value preferred shares in the Holdco with a redemption amount equal to the FMV of the operating company at the time of the freeze. New common shares of the Holdco are then issued to the owner’s family members or a family trust at nominal value, representing the future growth equity.
The tax result: the owner’s accrued gain on the common shares is deferred (rolled into the Holdco preferred shares at the elected amount). Future growth in the operating company accrues to the new common shareholders, who each accumulate their own ACB and, eventually, their own LCGE eligibility on those shares.
If a family trust holds the new common shares, the trust can allocate capital gains to multiple beneficiaries on a sale, with each beneficiary potentially claiming approximately the $1,275,000 (2026 indexed figure) LCGE. A single operating company sale can shelter multiple LCGE exemptions if the freeze was implemented far enough in advance.
The 24-month holding period for QSBC shares means that family members or the trust must have held their shares for at least 24 months before the sale for the LCGE to apply. A freeze done two years before a planned sale is ideal; a freeze done six months before a sale does not provide LCGE access for the new shareholders.
Use 3: Incorporating a sole proprietorship or partnership interest
Where a business has been operating as a sole proprietorship or a partnership, a section 85 rollover allows the owner to transfer the business assets into a corporation on a tax-deferred basis. Without a section 85 rollover, incorporating a profitable business means recognizing the accrued gain on goodwill, customer relationships, and other capital property at the time of incorporation.
With a section 85 rollover, the transferor elects an amount equal to the cost amount of each asset transferred. The gain is deferred into the shares of the new corporation. Once the business is operating through a corporation, the shares can qualify as QSBC shares (subject to the holding period and active business tests), making the LCGE potentially available on a future sale.
Filing the Section 85 Election: Form T2057
The section 85 election is a joint election made by the transferor and the transferee corporation. It is filed on CRA Form T2057 (or Form T2058 for partnerships). Both the transferor and the corporation must sign the form.
Filing deadline: The election must be filed by the earliest of the filing due date of the transferor’s income tax return for the year of the transfer and the filing due date of the transferee corporation’s income tax return for its taxation year in which the transfer occurred. In practice, this means the election must typically be filed with the first income tax return due after the transfer, whether that is the individual’s T1 (April 30 of the following year) or the corporation’s T2 (within six months of the corporation’s fiscal year end).
Late elections: CRA allows late-filed T2057 elections in certain circumstances, subject to a penalty of the lesser of $100 per month (from the due date to the actual filing date) and $8,000. The late election must be filed within three years of the original due date. Beyond three years, the ability to elect is lost, and the transfer is taxed at fair market value.
The importance of filing on time cannot be overstated. A missed T2057 filing on a significant asset transfer results in the full gain being recognized in the year of transfer, with no ability to correct it years later.
The Section 84.1 Trap
One of the most important limitations on Section 85 rollovers used in a pre-sale context involves ITA s. 84.1, which applies when
- A Canadian resident individual (or a person not dealing at arm’s length with them) disposes of shares of a “subject corporation” to a corporation with which the individual does not deal at arm’s length, AND
- The transferee corporation is connected to the subject corporation after the transfer.
In plain terms: if you use a Section 85 rollover to transfer shares of your operating company to a new holding company that is controlled by you, s. 84.1 may deem a dividend on the transfer rather than allowing the usual rollover treatment. The deemed dividend eliminates or reduces the paid-up capital of the shares received, which in turn can affect the availability of the LCGE on a subsequent sale of those shares.
Section 84.1 is specifically designed to prevent “surplus stripping”: the extraction of retained earnings from a CCPC at capital gains rates rather than dividend rates. The section 85 / s. 84.1 interaction is one of the most technically complex areas of Canadian tax law and one of the most consequential errors in pre-sale planning. It requires careful analysis and structuring by qualified tax counsel before any share-level rollover is implemented.
ACB and FMV Considerations
The Section 85 rollover requires accurate knowledge of two numbers: the ACB of the property being transferred and the FMV of that property at the time of transfer.
ACB: The ACB of shares or capital property is not always what the owner paid for them. It is affected by capital gains dividends received, stock dividends, return-of-capital distributions, capital loss adjustments, and any previous tax elections. Before implementing a section 85 rollover, the ACB of each item of property should be confirmed with precision.
FMV: The FMV of shares of a private corporation requires a formal or informal valuation. CRA can challenge an elected amount that is below the FMV of the transferred property (since the upper limit is FMV, an amount above FMV is not permitted, but an amount at or below it may be challenged if CRA considers the FMV to have been understated). For significant transactions, an independent business valuation is advisable.
The FMV also governs the value of the preferred shares issued in an estate freeze: if the preferred shares are redeemable for an amount less than the FMV of the transferred property, the common shares issued to family members will have a positive FMV at the time of issuance, which may trigger a deemed benefit or a gift.
When Should You Consider a Section 85 Rollover Before a Sale?
A section 85 rollover is worth considering in the following situations:
You have a sole proprietorship or professional corporation with significant goodwill. If you are planning to sell and have not incorporated, a section 85 rollover can allow you to incorporate tax-efficiently before the sale so the proceeds are received by a CCPC rather than personally.
Your operating company holds excess cash or passive investments. A section 85 rollover can move those assets to a holding company, allowing the operating company to satisfy the QSBC 90% active business test.
You want to multiply the LCGE across family members. An estate freeze implemented through a section 85 rollover, done at least 24 months before the sale, can allow multiple family members or a family trust to shelter separate approximate $1,275,000 LCGE amounts on the same transaction.
You are restructuring your corporate group before a sale. Moving assets between related companies, cleaning up corporate structure, or creating a clean operating company for the buyer are all transactions that may involve section 85 elections.
What a section 85 rollover is not: a last-minute fix. The 24-month QSBC holding period means any restructuring needs to happen well in advance. CRA also scrutinizes pre-sale restructuring for transactions that appear to be designed solely to create LCGE eligibility without substantive business purpose. The timing and structure of the rollover must be documented and defensible.
How Kalfa Law Firm Can Help
At Kalfa Law we implement section 85 rollovers as part of a coordinated pre-sale tax and legal plan. We advise on whether a rollover is appropriate given your specific corporate structure, coordinate with your accountant on the elected amounts and the FMV analysis, draft the transfer documents and shareholder resolutions, file the T2057 election, and ensure the restructured shares satisfy the QSBC tests in time for the planned sale.
Section 85 is not a form you file. It is a transaction that needs to be designed correctly from the start, because a poorly structured rollover can trigger the very gains it was intended to defer.
Find out if a section 85 rollover applies to your sale; book a call.
FAQs:
Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and private M&A law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law.
© Kalfa Law Firm | August 19, 2026
The above provides information of a general nature only. This does not constitute legal or accounting advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
