Generally when a dispo­sition of capital property occurs, a gain or loss is recog­nized. Occasionally the dispo­sition results in no real change to the economic interest of the property, like when an individual transfers property to a corpo­ration they own. A rollover provides a way to defer the gain or loss.

Section 85 of the Income Tax Act is where the magic happens. One caveat: The trans­feror must take back shares in the tranferee corpo­ration in consid­er­ation, at the fair market value of the assets trans­ferred. The adjusted cost base of the shares will equal the ACB of the assets. Now if the shares are sold to an unrelated third party (an “arm’s length trans­action”) they will fetch the FMV and the gain will be realized. Until that happens though, the gain and tax is deferred.

This works even if the asset being trans­ferred is shares in an operating company. The beauty of Section 85 is it is an election — the trans­feror can decide and elect the cost of the asset being trans­ferred anywhere between the ACB and FMV. For example, shares with an ACB (or “tax value”) of $100 and FMV of $150 can be trans­ferred at $125, to elect to recognize a gain of $25.

This is how the capital gains exemption is “crystal­lized”. You can transfer shares of an operating company into a holding company and elect to recognize a $500,000 gain, to use the CGE. The tax value of the shares is bumped up, you’ve utilized the tax advantage of the exemption, and you can go forward as normal, since you received back shares in the holding company worth the new value (the original cost of the operating company shares plus the $500,000 elected gain) in exchange.

As you can imagine this allows some flexi­bility when it comes to general tax or estate planning. For example, you could offset a capital loss that is expiring by recog­nizing the equal amount of gain. Or you could take back preferred shares in the holding company from the paragraph above after crystal­lizing the exemption, and have your children subscribe to common shares, so that future growth of the operating company accrues to the children.

The following condi­tions are required to be met for the rollover to apply:

• the trans­feree must be a taxable Canadian corporation
• consid­er­ation received must include shares in the corpo­ration or a fraction of a share
• the property trans­ferred can be depre­ciable or non-depreciable capital property, a resource property or inventory
• a joint election by both parties must be filed

This is just a summary of the very basics of this complex section of the Act. As with any general tax discussion, your personal situation is unique and requires the expertise of a Chartered Accountant. If you need a CA, please contact me and I can provide a referral.