Section 85 Rollover for Incorporating a Sole Proprietorship

When you start your owner business, it is a good choice for starting from a sole proprietorship business. Once the business gradually grows to a stable stage, you might consider incorporating your business from a sole proprietorship. In this transition, you could get tax deferral by applying a special technique called Section 85 Rollover in the process of transferring eligible property from your sole proprietorship to a corporation. 

What is Section 85 Rollover?

A Section 85 Rollover is a special election filed with the CRA at the time incorporating a sole proprietorship. It allows the business owners to defer all or part income for their assets at the time to be transferred from sole proprietorship to newly corporation. This could help taxpayers to reduce their personal income tax in the process of business change. But it does not eliminate tax indefinitely. The tax liability is deferred to the time of the assets transferred to the corporation being ultimately sold.

Lots of our business clients in Northumberland will experience the business transition from a sole proprietorship to a corporation. Please consult with Pivotop Accounting Services for the tax implication resulting from this change.

A Simple Example of How Section 85 Rollover Works

John started his John Renovation business as a sole proprietorship five years ago. He decided to incorporate his business as the business has been growing and stable. At the time of incorporation, John Renovation has accumulated assets of $150,000 in fair market value, which included a truck, equipment, website, and custom list. 

When the amount of $150,000 property was transferred from sole proprietorship to corporation, John realized a capital gain of $150,000-$30,000=$120,000 (assume the UCC of truck and equipment was $30,000 at the time of incorporate). Therefore, he must file this income in his personal income tax as a capital income at the year-end of incorporation.

When Section 85 Rollover is applied, CRA allows John to transfer the $150,000 of assets from his sole proprietorship to the corporation in an amount smaller than its fair market value, for example, $30,001. John just realized a capital gain of $30,001-$30,000=$1 (assume the UCC of truck and equipment was $30,000 at the time of incorporation). Therefore, he only needs to file a $1 capital gain in his personal income tax at the year-end of incorporation. The remaining capital gain of $120,000-$1=$119,999 could be deferred to the time when John sells his share of the corporation to someone else, for example, 10 years later. At the year-end John sells his share to someone else, he needs to file his $119,999 deferred capital gain in his personal income tax.

John gets a benefit for deferring his $119,999 of capital gain income and capital gain tax for 10 years by applying the Section 85 Rollover.

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