If you have been operating your professional practice as a proprietorship for some time, you may have built up significant assets in your unincorporated practice. If you’ve made the decision to incorporate your practice, the question becomes: how can I transfer the assets from my proprietorship (personal asset) into my new professional corporation (PC) in the most tax-efficient manner possible?
Section 85 Rollovers
Normally, when you transfer assets it must be done at fair market value. For example, if you have an investment portfolio which originally cost $100,000 but is now worth $150,000, the portfolio must be transferred in at $150,000 if no tax elections are made. This would require you, the individual, to report a $50,000 capital gain on your personal income tax return.
The Income Tax Act contains a provision for transferring assets from a personal proprietorship to a corporation when the corporation carries on the proprietorship’s business. Known as a Section 85 Rollover, this provision allows for the transfer of assets at values ranging from their original cost up to their fair market value. If the assets are transferred at their original cost, there will be no capital gain to report on your personal income tax return.
What can be transferred using a Section 85 Rollover?
- Real Estate (as long as it’s used in the professional practice)
- Investment Portfolio
- Goodwill
What can’t be transferred using a Section 85 Rollover?
- Insurance Contracts (they can only be transferred at fair market value)
- Student Loans
- Debt (unless it is tied to a transferable asset such as real estate or an investment portfolio)
Other assets that can be transferred but do not require a Section 85 Rollover are cash, accounts receivable, inventory, and prepaid expenses. A Section 85 Rollover is not necessary in these cases as both the cost and fair market value of these assets are normally the same (especially if you haven’t been running your professional practice for very long). Also, if your real estate or investments haven’t appreciated much above their original cost, it may not make sense to incur the accounting costs of the Section 85 Rollover.
A Note About Real Estate
One final thing to discuss is the holding of real estate in a professional corporation (PC). The college of physicians and dentists in every province and territory in Canada specifically forbids PCs from holding non-professional practice real estate. The Colleges want the focus of your PC to be the practice of medicine or dentistry. They do not want the focus on being a landlord. Therefore, if you wish to hold real estate as an investment, you must do so personally or through a separate holding company.