Moving a Sole Proprietorship Into a Corporation: When a Section 85 Rollover May Help
Learn when a Section 85 rollover may help transfer a sole proprietorship into a corporation, what T2057 does, and which tax issues Canadian owners should review first.
By Majdi Ibrahim, CPA | Majdi Ibrahim, CPA Professional Corporation | Ottawa, Ontario
If you started as a sole proprietor and the business has grown, incorporation may now be on the table. Maybe the business has steady profit, equipment, client relationships, a recognizable brand, or contracts you want the new corporation to use.
That is where many owners run into a tax issue they did not expect: you and your corporation are separate taxpayers. Moving property from yourself personally into the corporation can be treated as a disposition for tax purposes. If property has gone up in value, or if equipment has been depreciated, the transfer may create tax unless it is planned properly.
A Section 85 rollover is one tool that may help. It can allow eligible property to move into a taxable Canadian corporation on a tax-deferred basis when the owner and corporation jointly elect and the owner receives shares as part of the consideration.
It is useful, but it is not automatic. It is also not needed in every incorporation.
At a Glance
- A sole proprietor and a corporation are different taxpayers.
- Transferring business property to the corporation can create a tax disposition.
- A Section 85 rollover may defer tax on eligible property when the owner and corporation jointly elect.
- The election is usually made on CRA Form T2057.
- Shares must be part of what you receive from the corporation.
- The elected amount is limited by tax rules and affected by fair market value, tax cost, and non-share consideration.
- Inventory, receivables, work in progress, real property, contracts, GST/HST, and liabilities may need separate review.
- This is a planning file, not just a form-filing task.
Why This Comes Up When a Sole Proprietor Incorporates
A sole proprietorship is not legally separate from you. The income is reported personally, and the business property is generally owned by you personally.
A corporation is different. It is a separate legal taxpayer. If the business continues inside a corporation, some property or rights may need to move from you to the corporation. That could include equipment, goodwill, a website, inventory, customer relationships, or other business property.
If you are still deciding whether incorporation makes sense at all, start with Treehouse CPA's guide to whether you should incorporate your business in Canada. Section 85 planning should come after the basic incorporation decision, not before it.
What a Section 85 Rollover Does
Section 85 of the Income Tax Act can let a taxpayer transfer eligible property to a taxable Canadian corporation and elect an amount for tax purposes. If the election is prepared correctly, the transfer may happen without triggering the full immediate tax that could otherwise arise from fair market value proceeds.
In plain English, it can let you move certain eligible property into the corporation while deferring some or all of the gain.
That does not mean the tax disappears. The tax cost is usually carried forward into the corporation, reflected in the shares you receive, or both. A future sale, withdrawal, restructuring, or asset disposition may bring the deferred tax back into the picture.
When It May Help
A Section 85 rollover may be worth reviewing when a sole proprietor has:
- equipment that has been depreciated for tax purposes
- goodwill or a client list with value
- a valuable business name, website, or brand
- appreciated capital property used in the business
- inventory or other operating assets that need a proper transfer plan
- liabilities the corporation may assume
- a business that may later involve shareholders, a holding company, or a sale
The rollover is especially relevant where the fair market value of property is higher than its tax cost. For background on why that matters, see Treehouse CPA's article on capital gains tax in Canada.
When It May Not Be Necessary
Not every incorporation needs a Section 85 election.
If you are a consultant with no meaningful equipment, no inventory, no goodwill value being transferred, and no property with built-in gains, the cost and complexity may not be worth it. The same may be true if the only thing changing is how future invoices will be issued.
That said, many owners underestimate goodwill, depreciated equipment, and customer relationships. A short review can prevent a messy filing problem later.
A Practical Example
Suppose an Ottawa sole proprietor has tools, a website, and a client list. The tools originally cost $40,000 and have been depreciated for tax purposes. The business also has goodwill because recurring client work is expected to continue.
If those items are simply moved into a new corporation at fair market value, the owner may have income, recapture, or a capital gain. With a properly prepared Section 85 election, the owner and corporation may be able to choose elected amounts that defer some of that tax.
The corporation might issue shares to the owner and may also assume certain business liabilities or issue a promissory note. That detail matters. Non-share consideration can limit how low the elected amount can be and may create immediate tax if it is too high relative to the property's tax cost.
What the T2057 Election Does
The election is normally filed using CRA Form T2057, Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation.
The form identifies the transferor, the corporation, the property transferred, the consideration received, and the elected amount for the property. The T2057 is generally due by the earliest income tax return filing due date of the transferor or transferee for the tax year that includes the transfer.
Late filing may be accepted in some circumstances, usually with a penalty, but it should be treated as a problem to avoid rather than a planning option.
What Needs Separate Review
Section 85 can apply to eligible property. It does not automatically solve every item on a sole proprietor's balance sheet.
Before filing anything, the owner and advisor should identify:
- which property is eligible for the election
- the fair market value of each material item
- the tax cost or undepreciated capital cost
- any debts, promissory notes, or other non-share consideration
- inventory, accounts receivable, and work in progress
- contract rights, deposits, prepaid expenses, and customer obligations
- real property or leasehold interests, if any
- GST/HST registration, account changes, and possible GST44 election issues
- legal transfer documents, corporate resolutions, and bookkeeping entries
The tax election does not replace legal transfer documents. The legal paperwork, accounting entries, and tax election should tell the same story.
GST/HST Is a Separate Question
GST/HST does not disappear just because the income tax rollover is available. If a GST/HST-registered sole proprietor transfers a business or part of a business to a corporation, a GST44 election may be available when its conditions are met. That review is separate from the Section 85 income tax election.
Some property and circumstances may be excluded or require special handling. The corporation may also need its own GST/HST account depending on the structure and timing.
Future Sale Planning and LCGE Caveat
Some owners incorporate because they are thinking ahead to a future sale. That can be sensible, but it needs careful wording.
A Section 85 rollover does not by itself make the new corporation's shares qualify for the lifetime capital gains exemption. Qualified small business corporation share status has separate asset-use and holding-period tests. If a future sale is part of the plan, the rollover should be coordinated with broader corporate and shareholder planning.
If the structure may eventually include a holding company, read Treehouse CPA's guide to holding company vs operating company planning in Canada.
Common Mistakes
Treating incorporation as just a legal step
The legal incorporation creates the corporation. It does not automatically move business property in the right tax way.
Guessing fair market value
Valuation affects elected amounts, share consideration, non-share consideration, and future tax cost. A rough guess can create problems if CRA later reviews the transfer.
Ignoring GST/HST
GST/HST should be reviewed separately. A GST44 election may be available for a business or part-business transfer, but only if its conditions are met.
Forgetting about personal services business risk
For some contractors, incorporation can create personal services business risk. Read Treehouse CPA's guide to personal services business rules in Canada before assuming a corporation improves the tax result.
Filing the election late
The T2057 deadline is not a casual administrative date. Missing it can create penalty exposure and uncertainty.
Recording the transfer in the books but not filing the election
Bookkeeping entries are not the same as a valid Section 85 election. The accounting, legal documents, and CRA election need to be coordinated.
Ottawa and Ontario Considerations
For an Ottawa, Kanata, Barrhaven, Orleans, or Gatineau-area owner, the practical work usually includes more than the tax election:
- incorporating federally or provincially
- setting up a corporate bank account
- moving contracts and customer billing
- reviewing GST/HST registration
- reviewing payroll if employees or owner salary will start
- updating bookkeeping
- setting up corporate records
- preparing for corporate tax filings after the first year-end
After incorporation, the business also needs normal corporate compliance. Treehouse CPA's corporate year-end tax planning checklist is a useful next read once the corporation is operating.
What Happens When You Bring This to Majdi Ibrahim, CPA?
Treehouse CPA would normally start by identifying what is actually being transferred. That includes equipment, inventory, goodwill, intellectual property, accounts receivable, debts, and any contracts or deposits that need separate treatment.
Then we would review fair market value, tax cost, GST/HST, T2057 filing requirements, and how the transfer should show up in the corporation's books. If the file is more complex, we would coordinate with the client's lawyer so the share subscriptions, asset-transfer documents, resolutions, and tax election match.
The goal is not to make incorporation sound complicated for its own sake. The goal is to avoid a preventable tax problem when the business moves from your personal return into a corporation.
Book a consultation at www.treehousecpa.com
FAQ
Do I always need a Section 85 rollover to incorporate?
No. It depends on what property is being transferred and whether there are built-in gains, recapture, goodwill, inventory, liabilities, or other tax-sensitive items.
Is a Section 85 rollover tax-free?
It is better described as tax-deferred. If done properly, it may reduce or avoid immediate tax, but the deferred tax can matter later when property or shares are sold or reorganized.
What form is used for a Section 85 rollover?
CRA Form T2057 is normally used for an election on a transfer of property by a taxpayer to a taxable Canadian corporation.
Can I file the T2057 after the deadline?
Late filing may be accepted in some circumstances, usually with a penalty, but late filing should not be treated as harmless or guaranteed.
Does Section 85 deal with GST/HST?
No. GST/HST is separate. A GST44 election may be available for a business or part-business transfer if its conditions are met, but exclusions and account-registration issues need review.
Does a Section 85 rollover make my shares eligible for the lifetime capital gains exemption?
No. A Section 85 rollover does not by itself make shares qualify for the lifetime capital gains exemption. Qualified small business corporation share status has separate asset-use and holding-period tests.
Disclaimer
This article is general information for Canadian business owners and is not personalized tax, legal, valuation, or corporate-law advice. Section 85 rollovers are fact-specific. Speak with a qualified professional before transferring property, issuing shares or promissory notes, changing GST/HST accounts, or filing an election.
