Section 85 Rollover
Why use Section 85?
Section 85 is useful and complex planning tool for sole proprietorship’s thinking about incorporating their business and it is also useful for succession planning such as estate freezes.
How does it work?
Sole Proprietorship to Incorporation
If an individual were to incorporate a business this would typically mean setting up a corporation and selling the assets to the corporation at fair market value which would result in taxes payable for the individual. However, to avoid this situation, an individual can transfer the assets of the business to a newly setup corporation through Section 85.
Individual setting up the corporation must become shareholder of the corporation, i.e. they must buy at least one share of the newly setup corporation. . Since assets are being transferred from an individual to a corporation, the corporation will pay consideration based on the elected price, usually fair market value. This consideration can be in the form of preferred or common shares.
Going back to deferred taxes, taxes are not paid when assets are transferred to the corporation, taxes will become payable when the corporation sells the assets.
If you want to transfer your business to the next generation, you could setup a holding company and issue shares in the holding company to yourself and anyone else you choose (successor).
You will have to make an election under Section 85(1) that would allow you to sell your shares to the holding company at the Adjusted Cost Base of the shares. The holding company would then issue preferred shares to you and common shares to your successor who will pay a nominal price for the shares. You can then crystallize the fair market value of the assets on a specific date which would trigger capital gains and thus ensuring that all future capital gains are transferred to the successor.
Consequences of crystallizing would be capital gain taxes would be payable by you. However, there is a way to avoid capital gains taxes by using the lifetime capital gains exemption. This would allow you to eliminate or lower your taxes payable based on how much lifetime capital gains exemption you have remaining.
Disclaimer: Information provided may not be complete or accurate. It should not be considered financial advice.