Optimizing Tax-Deferred Asset Transfer: A Section 85 Analysis

Introduction

Transferring assets within a corporation while minimizing the immediate tax implications is a strategic move that requires careful consideration. In this context, Sally’s intention to transfer her assets to ABC Limited in exchange for note payable and preferred shares while deferring income recognition for tax purposes presents a significant opportunity. To achieve this goal, Sally and Limited Inc. can jointly make a Section 85 election. This election allows for the deferral of gains or losses that would typically arise from the transfer of property between related parties.

Section 85 Election and its Significance: The Section 85 election under the Income Tax Act is a provision that enables taxpayers to transfer property to a corporation while deferring the immediate recognition of capital gains or losses. This election is often employed in situations where individuals wish to exchange property for shares, debt instruments, or other consideration without triggering an immediate tax liability. For Sally, the Section 85 election presents a mechanism to optimize her asset transfer to ABC Limited, ensuring that she receives the maximum amount in note payable while deferring income recognition.

Asset Analysis

Let’s delve into the details of each asset that Sally intends to transfer, considering the Fair Market Value (FMV), Adjusted Cost Base (ACB), and Undepreciated Capital Cost (UCC) for each.

Equipment

FMV: $77,500

ACB: $95,000

UCC: $56,000

To calculate the gain/loss that would be deferred under the Section 85 election, we subtract the ACB from the FMV: Gain/Loss = FMV – ACB = $77,500 – $95,000 = -$17,500 (Loss). This loss would be deferred upon making the Section 85 election.

Land

FMV: $145,000

ACB: $100,000

UCC: N/A

Since the land has no UCC, there would be no recapture or terminal loss to consider. The gain/loss deferred under the Section 85 election is Gain/Loss = FMV – ACB = $145,000 – $100,000 = $45,000 (Gain).

Building

FMV: $155,000

ACB: $98,000

UCC: $88,000

The deferred gain/loss would be Gain/Loss = FMV – ACB = $155,000 – $98,000 = $57,000 (Gain).

Goodwill

FMV: $60,000

ACB: N/A

UCC: N/A

Since the ACB is not available for goodwill, the entire FMV would be treated as a gain under the Section 85 election.

Optimizing Payment for Assets: Sally’s objective is to receive the maximum amount in note payable while deferring income recognition. Therefore, the consideration she receives should be structured to align with this goal. Let’s analyze the payment structure for each asset:

Equipment: Considering the $17,500 loss deferred, Sally could potentially receive a higher note payable of this amount in exchange for the equipment.

Land: With a deferred gain of $45,000, Sally could choose to receive a note payable for this amount or a combination of cash and preferred shares, depending on her financial preferences.

Building: Given the deferred gain of $57,000, Sally could negotiate to receive a note payable or a mix of cash and preferred shares up to this value.

Goodwill: Since the entire FMV of $60,000 is deferred gain, Sally’s consideration would likely consist of a note payable or preferred shares to the extent of this value.

Conclusion

Sally’s decision to transfer her assets to ABC Limited using the Section 85 election is a well-thought-out strategy to optimize her tax position. By deferring gains and losses, Sally can structure her consideration to align with her financial goals, allowing her to receive the maximum amount in note payable while postponing income recognition. The intricacies of each asset’s gain/loss and the consideration received highlight the importance of prudent financial planning and the strategic utilization of tax provisions to achieve long-term objectives. Collaborating with tax professionals is advisable to ensure the accurate execution of this complex process.