Income Tax Act Section 85 Rollover: Agreed Amount, PUC, and Election

A Section 85 rollover under Canada’s Income Tax Act lets you transfer property to a taxable Canadian corporation at an elected tax cost instead of at fair market value, deferring the capital gain or recaptured depreciation you would otherwise owe. Without the election, moving an asset into a corporation counts as a disposition at fair market value even though no outside sale has happened. The rollover recognizes that a change in ownership form should not, by itself, force a tax bill when you keep an ongoing interest through shares of the receiving corporation.

What Property You Can Roll Over

Subsection 85(1.1) sets out the eligible categories, and they cover most business assets.

Depreciable capital property: machinery, equipment, vehicles, buildings, and other assets you claim capital cost allowance on. Since January 1, 2017, this category also includes former “eligible capital property” such as goodwill, trademarks, and customer lists, which are now Class 14.1 depreciable property.
Non-depreciable capital property: shares of other corporations, partnership interests, and similar holdings.
Canadian and foreign resource properties: mineral rights, oil and gas reserves, and similar resource interests.
Inventory, but not real property held as inventory. A developer holding land for resale cannot roll that land over.

Real property owned by a non-resident is generally excluded from eligible property under paragraph 85(1.1)(a). Two exceptions exist: real property owned by a non-resident insurer that qualifies as designated insurance property, and real property a non-resident uses in a business carried on in Canada.¹ The exclusion targets passive non-resident real estate holdings, not active business property.

Who Can Receive the Property

The transferee must be a taxable Canadian corporation: resident in Canada and not exempt from tax under another part of the Act. A corporation qualifies as a “Canadian corporation” if it was incorporated in Canada or has been resident in Canada continuously since June 18, 1971.² Foreign corporations and tax-exempt non-profits are not eligible transferees.

One condition ties the whole transaction together: you must receive at least one share of the corporation’s capital stock as part of the consideration.³ Cash, a promissory note, or other non-share consideration (commonly called “boot”) can be layered in alongside, but at least one share is mandatory. Deferring tax requires that you retain a continuing equity stake in whatever now holds the asset.

Setting the Agreed Amount

The agreed amount is the single most important number in the election. It becomes your deemed proceeds of disposition and the corporation’s cost of the property, so it decides how much tax you defer and what cost base the corporation carries forward.¹

The Act limits where you can land:

Upper limit: the agreed amount cannot exceed the property’s fair market value at the time of transfer. Set it higher and the Act deems it equal to fair market value.
Lower limit: the agreed amount cannot be less than the fair market value of any non-share consideration you receive.

To defer all tax, you typically set the agreed amount at the property’s tax cost: the adjusted cost base for non-depreciable property, or the undepreciated capital cost for depreciable property. At those levels, no gain or loss is triggered. If the boot you take back exceeds the property’s tax cost, paragraph 85(1)(b) automatically pushes the agreed amount up to match the boot, and you realize a gain on the difference.¹ This is the most common way people create an accidental tax bill in a rollover: taking too much boot.

Setting the agreed amount below the tax cost does not create a usable loss. No terminal loss or capital loss is recognized on an internal transfer, and the deferred gain simply stays embedded in the asset until the corporation disposes of it to a third party.

The Indirect Gift Rule

Paragraph 85(1)(e.2) catches transfers that effectively gift value to a related shareholder. If the fair market value of the property you transfer exceeds the greater of the total consideration you receive and the agreed amount, and the CRA views the excess as a benefit conferred on a related person, the agreed amount is automatically increased by the amount of that benefit.¹ The bump-up happens regardless of what the election paperwork says.

The rule most often bites when a parent transfers property to a corporation partly owned by their children and takes back consideration worth less than the property. The shortfall is treated as a gift to the children through the corporate structure, and the parent’s deemed proceeds rise, triggering a gain. Transfers to a corporation wholly owned by the transferor are outside the rule, since you cannot gift value to yourself.

Paid-Up Capital of the Shares You Receive

Subsection 85(2.1) reduces the paid-up capital of shares issued to you in the rollover. Without this rule, you could transfer a low-cost asset, take back shares with paid-up capital equal to the property’s full fair market value, and later extract that value tax-free as a return of capital.¹

In practice, the paid-up capital of the shares you receive generally equals the agreed amount minus the boot. The consequence is that those shares carry a low PUC, which limits how much the corporation can later return to you tax-free through redemptions or capital reductions.

Watch for Section 84.1 on Share Transfers

Section 84.1 is the anti-avoidance rule that most often trips up people using a Section 85 rollover to move shares of one corporation into a holding company. It applies when an individual (not a corporation) disposes of shares of a “subject corporation” to a non-arm’s length “purchaser corporation,” where the two corporations are connected immediately after the transfer.⁴

When Section 84.1 applies, it caps the combined non-share consideration and paid-up capital you can receive at the greater of the shares’ paid-up capital or their “hard” adjusted cost base. Hard ACB strips out any cost base derived from pre-1972 valuation day values or from capital gains exemptions previously claimed by you or a related person. Anything above that cap is recharacterized as a deemed dividend rather than a tax-free return of capital or a capital gain.⁴

Dividends are taxed at a higher effective rate than capital gains for most individuals, so this recharacterization hurts. If you have used the lifetime capital gains exemption on prior share dispositions, Section 84.1 can substantially reduce the boot you can safely extract. Any reorganization moving operating company shares into a holdco needs a Section 84.1 review before the election is filed.

Crystallizing the Capital Gains Exemption

A common strategic use of the rollover is “crystallizing” the Lifetime Capital Gains Exemption on qualified small business corporation shares. Instead of setting the agreed amount at tax cost, you deliberately set it higher to trigger a capital gain that you offset with your available LCGE. The LCGE for qualified small business corporation shares was $1,250,000 for 2025 and is indexed annually for inflation.⁵

After the rollover, the new shares carry a stepped-up adjusted cost base equal to the higher agreed amount, which reduces or eliminates the gain on a future sale. Crystallization matters because qualified small business corporation status depends on strict asset tests that can shift. If a corporation accumulates too much passive investment property, it can lose that status and the LCGE becomes unavailable going forward. Crystallizing locks in the exemption while the shares still qualify.

How the 2026 Inclusion Rate Change Affects the Math

Starting January 1, 2026, the capital gains inclusion rate rises from one-half to two-thirds on annual capital gains above $250,000 for individuals and on all capital gains realized by corporations and most trusts.⁶ The rollover becomes more valuable in some scenarios and less obviously beneficial in others.

For a corporation that receives property through a rollover, every dollar of deferred gain that eventually surfaces will face the two-thirds inclusion rate. That may still beat triggering the gain personally if the gain exceeds $250,000, since you would face the higher rate at the individual level anyway. For smaller gains under the $250,000 threshold, the individual one-half rate may be lower than the corporate rate, and the deferral math tightens.

The Canadian Entrepreneurs’ Incentive is a related consideration. It reduces the inclusion rate to one-third on eligible capital gains up to a lifetime maximum that phases in at $400,000 per year starting in 2025 and reaches $800,000 for 2026.⁶ For qualifying dispositions, triggering the gain outside the rollover may end up more tax-efficient than deferring it into a corporation where the lower rate would not apply.

Price Adjustment Clauses

Valuations in a rollover are rarely precise, and a CRA reassessment of fair market value can throw off every number in the election. A price adjustment clause in the transfer agreement automatically adjusts the purchase price to whatever value the CRA or a court ultimately determines.

The CRA recognizes a price adjustment clause only when four conditions are met:⁷

The parties genuinely intended to transact at fair market value. A wildly off-base valuation suggests otherwise.
The valuation method is fair, reasonable, and generally accepted. A professional appraiser is not required, but the method must fit the circumstances.
The parties agree in writing to accept whatever value the CRA or a court determines if it differs from theirs.
The consideration is actually adjusted when the value changes. Paper clauses that never get implemented do not qualify.

For share-based consideration, adjustments usually work through a change in the redemption value of the shares or in the principal amount of a promissory note.

Filing the Election

The election is filed jointly by the transferor and the corporation on Form T2057 (individual transferor) or Form T2058 (partnership transferor).⁸⁹ Each asset needs a separate description with its fair market value, adjusted cost base, the agreed amount, and full details of the consideration received, including the number and class of shares issued.

The deadline is the earliest date any party to the election must file their income tax return for the taxation year in which the transfer occurred. In most cases the corporation’s filing date drives the timeline, since corporate returns are due six months after fiscal year-end while individual returns are not due until April 30.

Late and Amended Elections

Missing the deadline is not fatal, but it costs. Subsection 85(7) allows a late-filed election for up to three years after the original deadline, provided you file the prescribed form and pay the estimated penalty at the time of filing.¹

The penalty under subsection 85(8) is the lesser of:

One-quarter of one percent of the difference between the property’s fair market value and the agreed amount, multiplied by the number of complete months late.
$100 per month late, to a maximum of $8,000.

The smaller number is charged, so on high-value property with a large spread between fair market value and agreed amount, the $100-per-month cap often controls.¹⁰

Beyond three years, subsection 85(7.1) gives the Minister discretion to accept a late or amended election where it is “just and equitable” to do so. The same penalty formula applies, and the election or amendment must be filed in prescribed form with the estimated penalty paid upfront. When an amendment is accepted, the original election is treated as never having been effective.¹

If You Are a U.S. Person

A Canadian Section 85 rollover does not carry over into the U.S. tax system. A U.S. citizen, resident, or domestic entity transferring property to a Canadian corporation (a foreign corporation from the IRS’s perspective) must file Form 926 with their U.S. income tax return for the year of the transfer.¹¹

Penalties for missing Form 926 are 10 percent of the fair market value of the transferred property, capped at $100,000 unless the failure was intentional. An additional 40 percent penalty can apply to tax underpayments tied to undisclosed foreign financial assets, and the IRS can extend the statute of limitations for assessment until three years after the required information is finally provided.¹¹ A FinCEN Report 114 (FBAR) filing may also be required if foreign financial account balances reach the reporting threshold. The Canadian deferral works on the Canadian side; the U.S. reporting and gain recognition rules are a separate analysis.

1
Justice Laws Website. Income Tax Act – 85
2
Justice Laws Website. Income Tax Act – 89
3
Canada Revenue Agency. Transfer of Property to a Corporation Under Section 85
4
Justice Laws Website. Income Tax Act – 84.1
5
Canada Revenue Agency. Line 25400 – Capital Gains Deduction
6
Canada.ca. Government of Canada Announces Deferral in Implementation of Change to Capital Gains Inclusion Rate
7
Canada Revenue Agency. Income Tax Folio S4-F3-C1, Price Adjustment Clauses
8
Canada Revenue Agency. T2057 Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation
9
Canada Revenue Agency. T2058 Election on Disposition of Property by a Partnership to a Taxable Canadian Corporation
10
Canada Revenue Agency. Penalty for Accepting a Late, Amended or Revoked Election
11
Internal Revenue Service. Form 926 – Filing Requirement for U.S. Transferors of Property to a Foreign Corporation