Without an election, the transfer is a sale at fair market value
The starting point is the trap, because everything else on this page exists to avoid it. You and your holding company are not dealing at arm's length, and the Income Tax Act refuses to let related parties pick their own prices. Transfer property to a corporation you control, for a dollar, for nothing, or for a number someone liked, and the Act deems the disposition to have happened at fair market value anyway. If your operating company has been growing for years, that deemed sale can put the entire accrued gain on your personal return in a single year.
The result is the worst of both worlds: a real tax bill with no sale proceeds behind it, since all you received was paper in your own holding company. Owners walk into this trap most often by treating the transfer as a legal formality, signing a share transfer form at a nominal price and assuming the tax follows the paperwork. It does not. The tax follows fair market value unless a specific provision says otherwise, and the provision built for this exact move is section 85. What it is and where it came from is covered in what is a section 85 rollover; this page is about running one correctly.
Section 85 lets you choose the transfer price, within hard limits
The rollover works by letting you and the holding company jointly elect the price at which the shares move, called the elected amount, and the Act then treats that amount as both your sale proceeds and the holding company's cost. Elect at your adjusted cost base and no gain arises at all: the transfer is fully deferred, and the holding company inherits your old cost base along with the built-in gain. That is the standard play when the goal is simply to put a holding company on top of the structure, a project we describe end to end in how do you add a holding company above an operating company.
The choice is bounded, not free. The elected amount cannot exceed the fair market value of the shares, and it cannot fall below the value of any non-share consideration you take back, with additional floors for particular kinds of property. Inside those bounds you can also elect somewhere in the middle on purpose, recognizing part of the gain now, which owners sometimes do to use capital losses or to crystallize the lifetime capital gains exemption while the shares still qualify. A partial gain on purpose is planning; a full gain by accident is the trap from the first section.
Every elected amount leans on one number the parties do not get to choose: fair market value. A defensible valuation, prepared before the transfer, is what the election stands on, and the transfer agreement should carry a price adjustment clause so that if the CRA later establishes a different value, the consideration adjusts retroactively instead of the election failing. On a goodwill-heavy business the valuation is the single most attackable part of the file, and it is where we spend a disproportionate share of the design time.
What you take back matters as much as the elected amount
Consideration is the second control surface, and it is where a tax-deferred transfer can quietly manufacture an immediate tax bill. The rollover requires you to take back at least one share of the holding company, and everything beyond shares, cash, a promissory note, assumed debt, is called boot. Boot is real value out of the corporate system, and two separate rules police it:
| What you take back | Tax result | The catch |
|---|---|---|
| Holding company shares only | Full deferral available, gain waits inside the structure | The new shares' paid-up capital is ground down to the old shares' level, so no new tax-free withdrawal room is created |
| A note up to the shares' historic cost and paid-up capital | Still deferred, and the note can be repaid to you tax-free over time | Only the genuinely hard historic numbers count, and on founder shares they are usually small |
| A note or cash beyond those numbers | The excess is deemed a taxable dividend under section 84.1 | This is the classic surplus-stripping trap, and it applies even when the section 85 election itself is perfect |
The logic behind the table is worth internalizing. Retained earnings inside a private company have never been taxed in the owner's hands, and the Act intends them to come out as dividends eventually. Section 84.1 exists to stop an owner from selling shares to their own holding company and pulling those retained earnings out as tax-free note repayments. Cost base created by the lifetime capital gains exemption or by pre-1972 history counts as soft for this purpose, so even an owner who genuinely paid tax-exempt gains into their cost base cannot convert it into a note against their own holdco.
Designed with that logic in mind, the consideration usually ends up simple: holding company shares for substantially all of the value, perhaps a small note where hard cost base genuinely exists, and no attempt to engineer withdrawal room the history does not support. Withdrawals are then planned the ordinary way, through compensation and dividends, where the real flexibility lives.
The T2057 election has three deadlines people miss
The election is not automatic and it is not implied by the lawyer's documents: it exists only if form T2057 is filed, jointly signed by you and the holding company, reporting the property, the consideration and the elected amounts. The form is due by the earliest date on which any party to the transfer has to file a tax return for the year of the transfer, which in practice usually means your holding company's first corporate return deadline or your own personal filing date, whichever lands first. That earliest-of rule is the first missed deadline, because each party assumes the other's date governs.
The second miss is the late-filing regime. A late T2057 can still be accepted for up to three years after the deadline, with a penalty that accrues monthly and is capped, and even later only where the CRA agrees to accept it under its discretion. Late is expensive but survivable; never-filed is the fair-market-value trap with interest. The third miss is consistency: the form has to match the legal documents, the share terms and the valuation exactly, because a reviewer reads them side by side. When the transfer is one step of a larger reorganization, each transferred property needs its own line and its own elected amount, and some transactions in the sequence may not need an election at all, a distinction we cover in when is a section 85 election required.
After the transfer, the structure has to be operated, not just filed
On the day after closing, the holding company is the shareholder of record, and three things change in practice. Dividends from the operating company now flow to the holding company rather than to you, generally tax-free between connected corporations, subject to the safe-income check we run before any large distribution. Your personal cash comes from the holding company or from employment compensation, which usually deserves a fresh salary-versus-dividend design. And the group now files two corporate returns a year, with intercompany balances that must be documented rather than remembered.
The minute book matters more after the rollover than before it. The share registers, the exchange agreement, the valuation and the filed election are the structure's title deeds, and every future transaction, a sale, a freeze, an estate plan, will be built on top of them. We store the complete rollover file as a single package because someone will need it in ten years, possibly urgently.
Five facts change how this transfer should be designed
The mechanics above are standard; the design around them is not. What moves it:
- How you acquired the shares. Founder shares, purchased shares, inherited shares and previously crystallized shares each carry different cost base and paid-up capital, and those histories set what consideration is safe to take back.
- The size of the accrued gain. A larger deferred gain raises the stakes on the valuation and on every number in the election.
- Your exemption plans. If a future sale might use the lifetime capital gains exemption, the transfer must not strand the shares in a structure that fails the qualification tests, and a deliberate partial crystallization may belong in the design.
- Losses and other attributes on your return. Existing capital losses can make a partial gain now genuinely cheap, which changes the elected amount.
- What the rest of the plan needs. A transfer that is step two of a freeze or a purifying reorganization has to be sequenced with the other steps, not designed in isolation.
This is the work a corporate reorganization and tax planning CPA in Ontario should own end to end: the valuation brief, the elected amounts, the consideration design, the T2057 and the lawyer's instruction memo. We run it as a defined-scope Strategic Project, starting with a free 15-minute discovery call and a written scope and fee before any work begins.
