Section 85 Rollover and Section 86 Estate Freeze: Tax Deferral and Succession Planning in Canada
Two of the most powerful tax planning tools available to Canadian business owners are the Section 85 rollover and the Section 86 estate freeze. Both allow shareholders and business owners to manage when tax is triggered on appreciated assets or shares, deferring it, shifting it, or capping it rather than having it arise unexpectedly on incorporation, reorganization, or death.
Used together, these two mechanisms form the foundation of most sophisticated business succession and intergenerational wealth transfer plans for privately owned corporations in Canada.
Section 85 Rollover: Transferring Property to a Corporation Without Triggering Tax
When you transfer personally owned property to a corporation, the Income Tax Act would normally treat that transfer as a disposition at fair market value, triggering a capital gain on any appreciation. Section 85 of the ITA overrides that result by allowing the transferor and the corporation to jointly elect a transfer price called the “elected amount” that can be as low as the property’s adjusted cost base (ACB). The corporation acquires the property at the elected amount as its cost, the transferor receives proceeds equal to the elected amount, and the accrued gain is deferred until the corporation eventually disposes of the property.
This is the rollover: accrued gains roll into the corporation without being immediately taxed. The tax doesn’t disappear; it’s deferred to a future disposition by the corporation but for a business owner who wants to incorporate a going concern or transfer personally held assets into a corporate structure, Section 85 is the mechanism that makes it tax-neutral.
The most common uses are incorporating a sole proprietorship or partnership (transferring business assets at ACB), adding a holding company above an existing operating company (rolling shares of the Opco into a HoldCo), and pre-sale restructuring to multiply access to the Lifetime Capital Gains Exemption across family members.
What property qualifies? Section 85 applies to capital property (shares, land, equipment, and real estate); goodwill and other intangibles now governed as Class 14.1 CCA property (customer lists, trademarks, and intellectual property); and inventory that has appreciated above cost. Not all property qualifies as real property that is not capital property, and certain other assets may not be eligible.
The elected amount and its limits: The elected amount cannot be lower than the fair market value of any non-share consideration (“boot”) received by the transferor, such as cash, a promissory note, or assumption of debt. It also cannot exceed the fair market value of the property transferred. Between these two bounds, the parties have flexibility to choose an elected amount that determines how much gain, if any, is recognized immediately. Setting the elected amount at the property’s ACB produces a full rollover with no immediate gain; setting it higher produces a partial gain.
Boot and the PUC trap: Boot received above the ACB of the transferred property triggers an immediate capital gain equal to the excess, which is why debt-heavy transfers require careful planning. More significantly, Section 85(2.1) restricts the paid-up capital (PUC) of the shares issued by the corporation to the elected amount, not the fair market value of the transferred property. If the corporation issues shares with a stated capital of $1 million (the FMV of the property) but the elected amount was $100,000 (the ACB), the PUC of those shares is limited to $100,000. The gap of $900,000 cannot be returned to the shareholder as a tax-free return of capital in the future. This PUC restriction is permanent and shapes how proceeds can eventually be extracted from the corporation.
Filing the election: The transferor and the corporation must jointly file CRA Form T2057 on or before the earlier of the transferor’s and the corporation’s tax return due dates for the year of transfer. Late filing is available within three years subject to penalties; beyond three years, only if the CRA considers it just and equitable, with penalties still applying.
Section 86 Estate Freeze: Capping the Founder’s Tax Exposure at Today’s Value
A Section 86 estate freeze is a corporate reorganization designed to fix a shareholder’s tax exposure as of today, while directing all future growth in the corporation’s value to the next generation. The mechanism: the existing shareholder surrenders their common shares, which hold the current value of the business, in exchange for newly issued preferred shares with a fixed redemption value equal to that current value. New common shares, which start at nominal value and will capture all future appreciation, are then issued to the next generation, often through a family trust.
The result is that the shareholder’s capital gain on death is effectively capped. When they die, the deemed disposition hits their preferred shares at their fixed redemption value, a known, quantifiable amount that can be planned for. The future growth of the business, which may be substantial, accrues in the hands of the next generation on their common shares and is taxed in their hands when eventually realized, often at lower marginal rates and with the benefit of their own LCGE.
PUC under Section 86: Unlike a Section 85 rollover, where PUC is limited to the elected amount, under Section 86 the PUC of the new preferred shares cannot exceed the PUC of the surrendered common shares. This is a critical constraint: if the common shares had a low PUC (common in incorporated businesses where shares were subscribed for nominal consideration), the preferred shares issued on the freeze will also have low PUC, regardless of their redemption value. The difference between the redemption value and the PUC of the preferred shares represents a future deemed dividend upon redemption rather than a return of capital, a point that must be factored into exit planning.
The valuation requirement: The Section 86 exchange must be at equal value: the preferred shares received must have a fair market value equal to the common shares surrendered. If the preferred shares are undervalued, for example, if the redemption value is set below the actual FMV of the business, there is a risk of a deemed benefit and adverse tax consequences under the shareholder benefit rules. A formal business valuation at the time of the freeze is essential to establish the correct redemption value.
Family trusts in the freeze structure: The new common shares issued after a freeze are most commonly held by a discretionary family trust rather than directly by the founder’s children. The trust allows the trustee (often a family member or trusted advisor) to allocate future income and capital gains among the beneficiaries in the most tax-efficient way each year, rather than locking in a fixed ownership percentage at the time of the freeze. The trust can also distribute LCGE-sheltered capital gains to multiple beneficiaries on a sale, multiplying the total shelter available. Kalfa Law Firm advises on succession planning structures, including family trusts, estate freezes, and shareholder agreements for the next-generation holdco structure.
Why the freeze is paired with life insurance. Once the freeze is in place, the founder’s tax liability on death is knowable; it’s the capital gain on the preferred shares, measured from today’s frozen value. That predictability allows the founder to obtain life insurance sized precisely to fund the tax liability, ensuring the family doesn’t need to liquidate business assets or borrow to pay the CRA on death. Without this planning, the deemed disposition on death can catch families off guard with a tax bill the estate cannot fund without a forced sale.
Thaw and refreeze: A freeze done too early can be problematic if the business declines in value and the founder is holding preferred shares with a redemption value above the current business worth, while the new common shares have negative effective value. In these situations, a “thaw and refreeze” can be undertaken, cancelling the preferred shares and reissuing common shares at the new lower value, then refreezing at the lower amount. These structures are complex and require legal and accounting advice.
Section 85 vs. Section 86: How They Work Together
| Section 85 Rollover | Section 86 Estate Freeze | |
| Primary purpose | Transfer assets to a corporation tax-free | Cap founder’s tax exposure at current value |
| When typically used | Incorporation; adding a Holdco; pre-sale restructuring | Succession planning; intergenerational wealth transfer |
| What changes hands | Property transferred for shares | Common shares exchanged for preferred shares |
| Tax-deferred | Capital gain on transferred property | Future growth above freeze value |
| PUC of new shares | Limited to elected amount (s.85(2.1)) | Limited to PUC of surrendered shares |
| CRA filing required | Yes, Form T2057 | No prescribed form; implemented by corporate resolution |
| Often combined with | Adding holding company; LCGE multiplication | Family trust; life insurance; LCGE planning |
These two tools are frequently used in sequence: a Section 85 rollover moves property into a corporation (or adds a Holdco), and a Section 86 freeze then caps the value of the operating company shares at a point when the business has grown to a meaningful value. For a deeper overview of how paid-up capital interacts with both mechanisms and how holding company structures are built above operating companies, see those articles.
Work with a Corporate Tax Lawyer at Kalfa Law Firm
Kalfa Law Firm advises business owners on Section 85 rollovers, Section 86 share exchanges, holding company structures, estate freezes, family trust planning, and succession. We work alongside your accountant to ensure the structure is correct, the documentation is in order, and the elections are filed on time.
Related Reading
Section 85 Rollovers and Section 86 Share Exchange · Paid-Up Capital and Stated Capital · Lifetime Capital Gains Exemption · Benefits of a Holding Corporation · Tax-Driven Reorganizations · Succession Planning · Corporate Tax Planning
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-Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax Foundation, Women’s Law Association of Ontario, and the Toronto Jewish Law Society.
© Kalfa Law Firm 2020, updated September 7, 2026.
