Section 85 Rollover: What Sole Proprietors Need to Know When Incorporating
Incorporating a sole proprietorship is a major milestone for Canadian business owners. It offers liability protection, access to corporate tax rates, and long-term planning flexibility. But without proper planning, it can also trigger unexpected tax consequences. One of the most effective tools to manage this transition is the Section 85 rollover, documented using Form T2057.
This election allows you to transfer assets into a corporation on a tax-deferred basis, avoiding immediate capital gains. It is especially important when transferring intangible assets like goodwill, which often carry real value despite having no cost base.
Why CRA Cares About Asset Transfers
When you transfer property to a corporation, the Canada Revenue Agency (CRA) treats it as a sale at fair market value, even if no money changes hands. This means that any appreciation in value becomes a deemed capital gain, which is taxable unless you elect otherwise.
For example, if you transfer goodwill worth $80,000 with a tax cost of $0, CRA considers that a taxable gain unless you file a Section 85 election.
What Is Form T2057?
Form T2057 is the official document used to make a Section 85 election. It must be signed by both the transferor (you, as the sole proprietor) and the transferee (your new corporation). The form includes:
A description of each asset being transferred
The fair market value (FMV), adjusted cost base (ACB), and elected transfer amount
The type and value of consideration received, including shares and non-share items
Form T2057 must be paper filed with CRA, attached to the transferor’s personal tax return. It cannot be submitted electronically.
When Should You Consider a Section 85 Rollover?
You should strongly consider a Section 85 rollover if:
You are incorporating a services-based sole proprietorship with intangible value such as client relationships, brand reputation, or referral networks
You are transferring assets with built-in gains, including equipment, inventory, or goodwill
You want to avoid triggering tax on incorporation and preserve future planning flexibility
You are issuing shares in exchange for assets and need to align legal and tax documentation
Even if your business has few tangible assets, internally generated goodwill can carry real value. CRA expects you to report this at FMV unless you elect otherwise.
How to Value Goodwill
Goodwill is typically valued using an income-based approach. For service businesses, this often involves:
Estimating normalized annual earnings
Deducting a fair return on tangible assets
Capitalizing the remaining “excess” earnings using a reasonable multiple
For example, if your business earns $120,000 annually and $40,000 is attributable to tangible assets, the remaining $80,000 may be capitalized at 3× to yield a goodwill value of $240,000. Even if you elect to transfer it at $1, you must document the FMV to support the election.
Share vs. Non-Share Consideration
The consideration you receive in exchange for the transferred assets affects whether the rollover is fully or partially tax-deferred.
Share Consideration
Receiving only shares allows for a fully tax-deferred rollover
You can elect to transfer assets at their tax cost, avoiding any immediate gain
This is the most common approach for sole proprietors incorporating service businesses
Non-Share Consideration (Boot)
Includes cash, promissory notes, or assumption of liabilities
If you receive boot, the elected amount must be at least equal to the boot value
Any excess of FMV over the elected amount becomes a taxable capital gain
For example, if you transfer equipment worth $20,000 with a tax cost of $10,000 and receive $5,000 cash plus shares, you must elect at least $5,000 to avoid triggering tax. Electing less would result in a taxable gain.
Legal Coordination and Documentation
The lawyer handling your incorporation must be informed of the Section 85 rollover. This ensures:
The share issuance resolution matches the elected values
The asset transfer agreement includes all relevant assets, including goodwill
Legal and tax documentation are aligned for audit safety
While lawyers typically handle the corporate setup, the accountant is responsible for preparing Form T2057 and ensuring the rollover is executed properly.
Final Thoughts
A Section 85 rollover is more than a tax deferral. It is a compliance safeguard that ensures your incorporation is clean, documented, and audit-ready. For service businesses, especially those with growing client lists or brand equity, it is worth considering whether goodwill exists and whether a rollover election is appropriate.
If you are unsure whether your business has goodwill, or how to value it, speak with a qualified advisor. Proper planning at the time of incorporation can prevent costly surprises later.