Section 85 Calculator: Evaluate Adjusted Cost Basis

Section 85 Calculation Breakdown

Component	Value

What is Section 85?

Section 85 of the Income Tax Act (Canada) is a crucial provision that allows individuals and corporations to transfer certain types of property (like capital property or eligible property not in inventory) to a Canadian corporation in exchange for shares, without triggering an immediate tax liability on any accrued capital gains or recapture of depreciation. Essentially, it facilitates a tax-deferred rollover. This means that instead of realizing a capital gain (or loss) at the time of transfer, the gain (or loss) is deferred until the shares received are eventually sold. The adjusted cost base (ACB) of the property transfers to the corporation, and the elected proceeds become the ACB of the shares received by the transferor. This is particularly useful for business owners looking to incorporate their operations or restructure their business assets.

Who should use it: Business owners, entrepreneurs, and corporations looking to move assets into a corporate structure while deferring immediate tax implications. This includes individuals transferring a sole proprietorship’s assets or a partnership’s assets into a newly formed corporation.

Common misunderstandings: A frequent misunderstanding is that Section 85 eliminates tax entirely. Instead, it defers it. Another confusion arises around the ‘elected amount’ – taxpayers might not fully grasp that this elected amount determines the proceeds for the transferor and the ACB for the corporation, impacting future tax liabilities. Unit confusion can also occur, especially when dealing with foreign currency or valuing complex assets, although this calculator primarily uses Canadian dollar values.

Section 85 Formula and Explanation

The core of a Section 85 transaction involves an election made by the transferor and the corporation. This election dictates the ‘deemed proceeds of disposition’ for the transferor and consequently the ‘adjusted cost base’ (ACB) for the corporation regarding the transferred asset. The goal is typically to minimize immediate tax while ensuring the ACB carries over correctly.

The general principle for the deemed proceeds of disposition is the elected amount, which must be within a specific range:

• Not less than the amount of any non-share consideration (cash, other property) received.
• Not more than the fair market value (FMV) of the property transferred.

For the purpose of calculating capital gains or recapture, the deemed proceeds are the elected amount. However, for calculating the ACB of the shares received by the transferor, the elected amount is used. The ACB of the asset in the hands of the corporation becomes this elected amount.

Variables Table

Variables Used in Section 85 Evaluation

Variable	Meaning	Unit	Typical Range
Business Income	Total revenue or income generated by the business operations.	CAD $	Variable, depends on business scale.
Business Expenses	Deductible costs incurred in generating business income (COGS, operating expenses).	CAD $	Variable, depends on business scale.
Capital Gains Inclusion Rate	The percentage of a capital gain that is taxable. Currently 50% for most capital gains.	% (Decimal)	e.g., 0.5
Asset FMV	The fair market value of the asset(s) being transferred.	CAD $	Positive value.
Asset ACB	The adjusted cost base of the asset(s) being transferred.	CAD $	Can be zero or positive.
Consideration Received	Cash or other property received by the transferor, excluding shares.	CAD $	$0 or positive value.
Elected Amount	The amount agreed upon by the transferor and corporation for the transfer. Crucial for ACB and proceeds.	CAD $	Between Consideration Received and Asset FMV.
Net Business Income / (Loss)	Profit or loss from core business operations before asset transfer effects.	CAD $	Can be positive, negative, or zero.
Capital Gain Before Inclusion	The total capital gain realized on the transfer (Deemed Proceeds – Asset ACB).	CAD $	Can be positive, negative, or zero.
Taxable Capital Gain	The portion of the capital gain that is included in taxable income.	CAD $	Capital Gain Before Inclusion * Inclusion Rate.
Deemed Proceeds of Disposition	The amount used to calculate the capital gain/loss for the transferor. Typically the Elected Amount.	CAD $	Equals Elected Amount (within bounds).
Adjusted Cost Base for New Entity	The cost base of the asset in the hands of the corporation. Equals the Elected Amount.	CAD $	Equals Elected Amount (within bounds).

Practical Examples

Let’s illustrate with two scenarios:

Example 1: Transferring a Business Asset with No Gain

Scenario: Sarah is transferring equipment with a Fair Market Value (FMV) of $15,000 and an Adjusted Cost Base (ACB) of $10,000 to her new corporation. She receives $5,000 in cash (consideration) and the rest in shares. She wants to defer the gain and set the ACB for the corporation appropriately.

Inputs:

• Business Income: $50,000
• Business Expenses: $30,000
• Capital Gains Inclusion Rate: 0.5
• Asset FMV: $15,000
• Asset ACB: $10,000
• Consideration Received (Cash): $5,000

Election: Sarah elects an amount of $15,000. This is within the acceptable range ($5,000 ≤ $15,000 ≤ $15,000).

Calculations:

• Net Business Income: $50,000 – $30,000 = $20,000
• Capital Gain Before Inclusion: $15,000 (Elected Proceeds) – $10,000 (Asset ACB) = $5,000
• Taxable Capital Gain: $5,000 * 0.5 = $2,500
• Deemed Proceeds of Disposition: $15,000 (Elected Amount)
• Adjusted Cost Base for New Entity: $15,000 (Elected Amount)

Result: Sarah defers the $5,000 capital gain at the time of transfer. The corporation acquires the equipment with an ACB of $15,000. The $2,500 taxable capital gain is realized in the year of transfer.

Example 2: Transferring a Business Asset with Minimal Consideration

Scenario: John is transferring a building to his corporation. The FMV is $500,000, and the ACB is $200,000. He receives only shares and no cash consideration. He wants to defer the entire gain.

Inputs:

• Business Income: $120,000
• Business Expenses: $80,000
• Capital Gains Inclusion Rate: 0.5
• Asset FMV: $500,000
• Asset ACB: $200,000
• Consideration Received (Cash): $0

Election: John elects an amount of $200,000. This is the minimum allowed since consideration is $0, and it’s less than the FMV.

Calculations:

• Net Business Income: $120,000 – $80,000 = $40,000
• Capital Gain Before Inclusion: $200,000 (Elected Proceeds) – $200,000 (Asset ACB) = $0
• Taxable Capital Gain: $0 * 0.5 = $0
• Deemed Proceeds of Disposition: $200,000 (Elected Amount)
• Adjusted Cost Base for New Entity: $200,000 (Elected Amount)

Result: John successfully defers the entire potential capital gain of $300,000 ($500,000 FMV – $200,000 ACB). The corporation acquires the building with an ACB of $200,000. No tax is immediately triggered on the capital gain.

How to Use This Section 85 Calculator

1. Input Business Performance: Enter your Business Income and Business Expenses to calculate the net business income/loss. This provides context but doesn’t directly impact the Section 85 rollover calculation itself unless it’s related to recapture on depreciable property.
2. Enter Asset Details: Input the Fair Market Value (FMV) and Adjusted Cost Base (ACB) of the asset(s) you intend to transfer.
3. Specify Consideration: Enter any cash or non-share property you will receive as part of the transfer. If you only receive shares, this will be $0.
4. Determine Your Election: This is the most critical step. The ‘Elected Amount’ must be between your ‘Consideration Received’ and the ‘Asset FMV’. A common strategy is to elect an amount equal to the Asset ACB to minimize or eliminate immediate capital gains tax. However, you might elect a higher amount up to the FMV if you wish to realize some gain now. The calculator assumes the minimum allowable election if not explicitly overridden by a similar field (which this simplified version does not have, it directly calculates based on inputs and implied election for ACB of new entity). For the calculator to show the minimum ACB for the new entity, the elected amount is effectively set to the ‘Consideration Received’ if it’s lower than FMV. For Deemed Proceeds, the elected amount (which drives ACB for new entity) is used.
5. Enter Inclusion Rate: Input the current capital gains inclusion rate (typically 0.5 or 50%).
6. Click Calculate: The calculator will display:
   • Net Business Income / (Loss)
   • Capital Gain Before Inclusion (Calculated as Elected Proceeds – Asset ACB)
   • Taxable Capital Gain (portion of the gain you pay tax on now)
   • Deemed Proceeds of Disposition (The value used for your tax calculation)
   • Adjusted Cost Base for New Entity (The value the corporation uses as its cost)
7. Review Assumptions: Carefully read the assumptions provided. Section 85 calculations can be complex and may involve other rules or recapture considerations for depreciable property not fully captured here.
8. Copy Results: Use the “Copy Results” button to save the calculated figures for your records or to share with your tax advisor.

Unit Selection: This calculator operates in Canadian Dollars (CAD). Ensure all inputs are in CAD. There is no unit switching required for this specific financial calculation.

Key Factors That Affect Section 85 Valuations

1. Fair Market Value (FMV) of the Asset: This is the highest potential value for the deemed proceeds and directly impacts the potential capital gain. Accurate valuation is key.
2. Adjusted Cost Base (ACB) of the Asset: A higher ACB reduces the potential capital gain, making the transfer more tax-efficient. Keep meticulous records of asset purchases and improvements.
3. Consideration Received: Any cash or non-share property received limits the maximum elected amount for shares and affects the minimum deemed proceeds.
4. The Elected Amount: This is the crucial figure chosen by the taxpayer and corporation. It sits between the consideration received and the FMV. It dictates the deemed proceeds for the transferor and the ACB for the corporation.
5. Type of Property Transferred: Section 85 applies to specific property types (capital property, eligible property not in inventory). Rules differ slightly for depreciable vs. non-depreciable property (recapture vs. capital gains).
6. Capital Gains Inclusion Rate: While currently stable at 50%, changes to this rate will affect the immediate tax impact of any capital gain realized during the transfer.
7. Business Income & Expenses: While not directly part of the rollover calculation, these figures determine the overall financial health of the business and might influence decisions about the elected amount or timing of the transfer.

FAQ

• Q1: What is the primary benefit of using Section 85?
  A1: The main benefit is tax deferral. It allows you to transfer assets into a corporation without immediately paying tax on accrued capital gains or recapture of depreciation.
• Q2: Can I transfer any asset under Section 85?
  A2: No, Section 85 generally applies to transfers of capital property or eligible property that is not inventory to a Canadian corporation. Depreciable property has specific rules regarding recapture of capital cost allowance (CCA).
• Q3: What is the ‘elected amount’?
  A3: It’s the value you and the corporation agree the transfer is worth for tax purposes. It must be between the cash/property received and the FMV of the asset. It determines the deemed proceeds for you and the ACB for the corporation.
• Q4: How does the ‘Consideration Received’ affect the calculation?
  A4: Any cash or non-share property you receive sets the minimum limit for your elected amount. You cannot elect an amount lower than what you received in non-share consideration.
• Q5: What happens if the FMV is much higher than my ACB?
  A5: You will have a capital gain. By electing an amount equal to your ACB (if possible, and if consideration received allows), you defer the capital gain. If you elect an amount equal to FMV, you realize the full capital gain now, and 50% of it becomes taxable income.
• Q6: Does Section 85 eliminate tax?
  A6: No, it defers tax. The tax is eventually paid when you dispose of the shares you received in the corporation.
• Q7: What are the units used in this calculator?
  A7: All monetary values are assumed to be in Canadian Dollars (CAD). The inclusion rate is a decimal representation of a percentage.
• Q8: Can I use Section 85 for losses?
  A8: Yes, Section 85 can also be used to defer losses, subject to specific rules, including potential limitations on the ability to transfer losses to the corporation.
• Q9: What is the difference between Deemed Proceeds and ACB for the New Entity?
  A9: For non-depreciable property, they are effectively the same – both are determined by the elected amount. For depreciable property, the deemed proceeds determine recapture/capital gain for the transferor, while the corporation’s capital cost allowance (CCA) base is also influenced by this elected amount, subject to rules preventing artificial inflation of CCA.