Introduction
The Section 85 Rollover is a valuable tax planning tool in Canada that allows individuals, businesses, and investors to transfer eligible assets—including crypto and digital assets—to a corporation without triggering immediate tax liabilities. This mechanism is widely used by crypto businesses, Web3 entrepreneurs, and digital asset holders to incorporate their operations while deferring capital gains tax.
By utilizing a Section 85 election, taxpayers can transfer assets to a corporation in exchange for shares, ensuring tax efficiency in corporate structuring and succession planning.
1. How the Section 85 Rollover Works for Crypto and Digital Assets
Under Section 85 of the Income Tax Act, an individual or business can transfer eligible assets to a Canadian corporation while deferring any capital gains that would normally be taxed.
a. Eligible Assets for a Section 85 Transfer
The following assets qualify for a Section 85 Rollover:
- Cryptocurrency holdings (Bitcoin, Ethereum, stablecoins, altcoins)
- Digital intellectual property (blockchain software, NFT collections, tokenized assets)
- Capital property (Web3 business shares, crypto mining equipment)
- Foreign and Canadian securities (publicly traded or private equity shares)
Assets such as cash, inventory, and real estate inventory do not qualify for rollover treatment.
2. Key Considerations When Using Section 85 for Crypto Transfers
To successfully execute a crypto asset transfer under Section 85, specific conditions must be met to ensure compliance with the Canada Revenue Agency (CRA).
a. The Transfer Must Include Corporate Shares as Consideration
- The taxpayer must receive at least one share of the corporation in exchange for the crypto or digital asset.
- These shares can be common shares, preferred shares, or a combination of both.
- Any additional non-share consideration (cash, promissory notes, or assets) must be within allowable limits to avoid triggering immediate tax.
b. The Transfer Price Must Be Fair Market Value (FMV)
- The elected transfer price must be fair and reasonable based on the FMV of the crypto asset at the time of transfer.
- The total consideration (shares + any additional payments) must equal the FMV of the transferred asset.
- If an asset is undervalued, the CRA may reassess the transaction and impose tax penalties.
Best Practice: To establish a fair transfer price, it is advisable to engage a crypto tax specialist or valuation expert who can provide an accurate FMV of the transferred digital assets.
3. Tax Benefits of a Section 85 Rollover for Crypto Holders
A Section 85 election provides significant tax advantages for crypto entrepreneurs and digital asset investors who want to incorporate their businesses or structure their holdings efficiently.
a. Tax Deferral on Capital Gains
- Normally, transferring crypto assets to a corporation would trigger capital gains tax on any appreciation.
- A Section 85 rollover defers taxation until the shares received in exchange are sold.
b. Incorporating a Crypto Business Without Immediate Tax Liabilities
- Crypto businesses, DAOs, and Web3 startups can transfer ownership of assets to a corporation tax-efficiently.
- This is especially beneficial for those seeking venture capital funding or legal structuring for compliance.
c. Estate Planning and Wealth Preservation
- Business owners can transfer crypto and digital assets into a corporation in exchange for preferred shares, locking in the asset’s value for tax purposes.
- Future growth of the business can accrue to common shareholders, such as family members or key employees, reducing estate tax liabilities.
4. Filing a Section 85 Election for Crypto and Digital Assets
To complete a crypto asset transfer using Section 85, both the transferor (individual or business) and the transferee (receiving corporation) must file Form T2057 with the CRA.
Key Filing Requirements:
- The election must be filed by the tax return due date for the year the transfer occurs.
- The transfer price must be clearly documented based on FMV valuation of the crypto assets.
- Both parties must agree on the transfer price and provide supporting documentation.
5. Common Mistakes to Avoid When Using Section 85 for Crypto Transfers
Taxpayers must be cautious of common errors that could lead to tax liabilities or CRA scrutiny:
a. Incorrect Valuation of Crypto Assets
- Underreporting the FMV of transferred crypto assets can result in a CRA reassessment and additional taxes.
- The CRA expects a well-documented valuation process, especially for highly volatile digital assets.
b. Receiving Too Much Non-Share Consideration ("Boot")
- If the transferor receives excessive cash, promissory notes, or other non-share consideration, part of the transaction becomes immediately taxable.
- To maintain full tax deferral, the majority of the transfer consideration should be in shares.
c. Late or Incorrect Filing of Form T2057
- Missing the filing deadline results in losing the tax deferral benefit, leading to immediate taxation on transferred assets.
- Filing errors, such as incorrect FMV or missing details, can lead to delays and CRA audits.
Conclusion
The Section 85 Rollover is a critical tax planning tool for crypto businesses, Web3 founders, and digital asset investors looking to transfer assets into a corporation without triggering immediate tax liabilities. However, the process requires proper valuation, compliance with CRA regulations, and accurate documentation.
To maximize tax benefits and avoid potential errors, it is highly recommended to consult with a crypto tax professional before executing a Section 85 election.
If you have any questions or require further assistance, our team at Block3 Finance can help you.
Please contact us by email at inquiry@block3finance.com or by phone at 1-877-804-1888 to schedule a FREE initial consultation appointment.
You may also visit our website (www.block3finance.com) to learn more about the range of crypto services we offer to startups, DAOs, and established businesses.