Section 85 of Canada's Income Tax Act provides a mechanism for transferring eligible property to a Canadian corporation on a tax-deferred basis. Without Section 85, transferring a commercial property to a corporation would be a deemed disposition at fair market value, triggering immediate recognition of any accrued capital gain or recaptured capital cost allowance.
Section 85 allows the transferor and the transferee corporation to jointly elect an amount (the elected amount) at which the transfer is deemed to occur for tax purposes. Provided the elected amount falls within the prescribed range (typically between the property's adjusted cost base and its fair market value), the transferor can defer the gain rather than crystallize it at the time of transfer, receiving shares of the corporation rather than cash as consideration.
The elected amount governs the tax outcomes for both parties. The transferor's proceeds of disposition equal the elected amount, so any accrued gain is deferred to the extent the elected amount is below fair market value.
The corporation acquires the property with a tax cost (adjusted cost base) equal to the elected amount rather than fair market value, meaning the deferred gain is preserved inside the corporation and will be realized when the corporation subsequently disposes of the property. The transferor's shares in the corporation also receive an adjusted cost base equal to the elected amount, so the deferred gain flows through to the share level.
The joint election is filed with the Canada Revenue Agency; failure to file on time results in the transfer being treated as a fair market value disposition, defeating the deferral.
In commercial real estate, Section 85 rollovers are most commonly used when individual investors or partnerships wish to incorporate a real estate portfolio, when family members want to transfer property into a family corporation as part of succession planning, or when a developer transfers land or completed projects into a holding company structure. The rollover can also be used in conjunction with Section 97(2) for transfers to partnerships, allowing real estate held personally to be moved into a limited partnership structure on a deferred basis.
Each use case involves trade-offs: the deferral reduces the corporation's tax cost in the property, which increases future CCA recapture exposure and reduces the depreciation shield available to the corporation going forward.
Section 85 interacts with several other provisions that require careful structuring. The paid-up capital of shares received in the rollover is generally limited to the elected amount under the deemed dividend rules of Section 84.1, which can restrict the transferor's ability to extract value from the corporation on a capital gains basis in subsequent transactions.
In estate planning contexts, a Section 85 rollover into a holding corporation followed by an estate freeze, using Section 86 or share exchange mechanics, allows the transferor to crystallize the current value in fixed-value preferred shares while growth passes to the next generation through new common shares. For cross-border transactions involving US investors holding Canadian real estate, the interaction between Section 85 and Part XIII withholding and the Canada-US tax treaty requires specialized advice, as treaty provisions may or may not preserve the deferral outcome available to Canadian residents.
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