Moving Your Sole Proprietorship Into a Corporation: The Section 85 Rollover Explained

Plenty of founders don't incorporate on day one — they build a sole proprietorship first, prove the business, and incorporate once the income justifies it. Smart sequence. But there's a trap at the transition: when you move business assets into your new corporation, the tax rules treat it as a sale at fair market value. If your business has grown in value, that "sale" can trigger real tax on gains you never received in cash. Section 85 of the Income Tax Act is the mechanism that defers it.

The Problem in One Example

Say you've built a consulting practice as a sole proprietor. Its client list, brand, and goodwill are now worth $200,000, but your cost is essentially nil — you built it from scratch. Transfer that goodwill to your corporation without planning, and you're deemed to have sold it for $200,000, creating a taxable capital gain of $200,000... with no cash proceeds to pay the tax.

What a Section 85 Rollover Does

A Section 85 election lets you and your corporation jointly elect a transfer price (the "elected amount") anywhere between the asset's tax cost and its fair market value. Elect at your cost, and no gain is triggered today — the gain is deferred into the shares you receive, and gets taxed only when you eventually sell those shares or the corporation sells the assets.

• You transfer: eligible property — goodwill, equipment, inventory, client lists, certain receivables.
• You receive: at minimum, shares of the corporation (this is mandatory — a rollover with no share consideration fails). You can also take back some non-share consideration ("boot"), like a promissory note, up to your tax cost without triggering gain.
• You file: CRA form T2057, due by the earliest tax return deadline of anyone involved in the election. Late filing is possible but comes with penalties.

What Usually Doesn't Need a Rollover

Not every incorporation needs Section 85. If your sole proprietorship has little accumulated value — you're a freelancer whose "assets" are a laptop and your own time — you can often simply start fresh: incorporate, open the new accounts, and begin invoicing through the corporation. Cash isn't rolled over (it's just deposited), and assets worth roughly what you paid for them transfer without meaningful gain. The rollover matters when there's appreciated value: goodwill, a brand, appreciated equipment, real estate, or inventory that's worth more than it cost.

The Boot Trap and Other Common Mistakes

• Taking too much boot. Non-share consideration above your tax cost triggers immediate gain — the most common self-inflicted wound in DIY rollovers.
• Forgetting the T2057. The rollover isn't automatic; no election filed means no deferral, even if everything else was done right.
• Ignoring HST. Asset transfers between you and your corporation can have GST/HST consequences; a joint election under section 167 can often make the transfer of a whole business HST-free — but again, only if elected.
• Valuing goodwill casually. The elected amounts and share values need a defensible fair market value behind them. A price adjustment clause in the transfer agreement is standard protection if the CRA later disputes the valuation.
• Transferring personal-use assets. Your personal vehicle or home office furniture rarely belongs in the corporation; the compliance cost usually exceeds the benefit.

What the Process Looks Like With a CPA

1. Inventory what the business owns and estimate fair market values.
2. Decide what transfers and what stays personal.
3. Incorporate with a share structure designed for the rollover (often a separate class of shares issued as consideration).
4. Sign a transfer agreement with a price adjustment clause.
5. File the T2057 on time, and the section 167 HST election if applicable.

Professional fees for a straightforward rollover typically run in the low four figures — cheap relative to paying tax today on a gain you haven't monetized. If you're incorporating an existing business, mention it when you start your Startcorp order and we'll flag whether your situation needs the election before anything is filed.