An estate freeze is one of the most durable ideas in Canadian tax planning. The premise is simple: fix the value of what you own today, and let future growth accrue to someone else — usually the next generation or a family trust. Freezing the value of your shares caps the capital gain that will be deemed to arise on your death under subsection 70(5) of the Income Tax Act, makes that future tax bill knowable and fundable, and moves the upside of a growing business into the hands of the people who will eventually run it. The harder question is not whether to freeze but how, and that is where sections 86, 85, and 51 come in.
Why freeze at all
On death, you are deemed to dispose of your capital property at fair market value. For an owner-manager holding common shares in a corporation that keeps appreciating, that deemed disposition grows every year the business does. A freeze converts your open-ended, growing common-share interest into a fixed-value interest — typically preferred shares with a set redemption amount. The deemed gain on death is then locked at today's value rather than tomorrow's, and the growth from the freeze date forward belongs to the new common shareholders. The freeze also creates an opportunity to multiply the lifetime capital gains exemption across family members, to introduce a family trust for income-splitting and flexibility, and to begin a structured succession while the founder is still in control.
Section 86: the capital reorganization freeze
Section 86 is the most common freeze technique when the freeze happens within a single corporation. It applies to a reorganization of the corporation's capital: the existing shareholder exchanges all of the shares of one class (the common shares) for shares of another class (fixed-value preferred shares) of the same corporation, as part of an amendment to the corporation's articles. New common shares are then issued — usually to a family trust or the next generation — to carry the future growth.
Section 86 is attractive because it does not require a joint election form the way section 85 does; the rollover is automatic where the conditions are met. The conditions are that the exchange occurs in the course of a reorganization of capital, that all of the shares of the exchanged class are disposed of, and that the consideration includes shares of the corporation. The preferred shares received are deemed to be acquired at the cost of the old common shares, so the accrued gain rolls forward into the freeze shares without being triggered. The trap is the same one that haunts every freeze: if the preferred shares are not drafted with a fixed redemption value, a retraction right, and proper ranking — so that their fair market value genuinely equals the value being frozen — the freeze can be incomplete and a deemed gift or a benefit can arise.
Section 85: the rollover freeze
Section 85 freezes by transferring the existing shares (or other appreciated property) to a corporation in exchange for fixed-value preferred shares, at a jointly elected amount. It is the technique of choice when the freeze is being combined with the insertion of a new holding company — the founder rolls operating-company common shares into a new holdco for holdco preferred shares, and the holdco's new common shares go to the trust or the next generation. Because section 85 requires a joint election on Form T2057 with a deliberately chosen elected amount, it offers more control than a section 86 freeze. The elected amount is usually set at the cost amount for a pure deferral, or at fair market value where the founder wants to crystallize the LCGE as part of the freeze. We explain the rollover mechanics in detail in our section 85 guide.
The cost of that extra control is paperwork and precision. The election must be filed on time and must match the transfer agreement; the share consideration's value must equal the value of the property transferred minus any boot; and the corporation's articles must already authorize the freeze-share class before the shares are issued. A section 85 freeze that gets the elected amount or the share terms wrong can trigger the very gain the freeze was meant to defer, or worse, a deemed gift under paragraph 85(1)(e.2).
Section 51: the convertible-property freeze
Section 51 provides a rollover where a shareholder converts a convertible property — typically a convertible debenture or a share that carries a conversion right under the corporation's articles — into shares of the corporation, without any non-share consideration and without a joint election. Where its conditions are met, the conversion happens on a tax-deferred basis automatically: the new shares inherit the cost of the converted property.
Section 51 is narrower than sections 86 and 85 and is used less often as the primary freeze tool, but it has a real place. It is clean and elective-free, which makes it useful where the share structure already contemplates a conversion right, or as a tidy step within a larger reorganization. Because there can be no boot in a section 51 exchange, it is not the right tool when the freezor wants to take back a promissory note — that is a job for section 85. The choice between section 51 and section 86 often comes down to whether the corporation's existing share terms already provide a conversion mechanism (favouring section 51) or whether a fresh reorganization of capital is being undertaken anyway (favouring section 86).
Choosing among the three
The three techniques overlap, and a competent plan often uses more than one in sequence, but a rough guide helps:
- Section 86 — when the freeze is internal to one corporation and no new holding company is being inserted. No election; automatic rollover within a capital reorganization.
- Section 85 — when the freeze involves dropping shares or property into a new or existing corporation, when boot is wanted, or when the founder wants the control that comes with a deliberately elected amount (including an LCGE crystallization). Requires a T2057 election.
- Section 51 — when a convertible property already exists and the freeze can be achieved by conversion, with no boot and no election.
Valuation: the foundation under every freeze
Every freeze rests on a fair market value. The freeze caps the freezor's value at the value of the corporation on the freeze date, so that number has to be defensible. For a business with readily ascertainable value, the figure may be straightforward; for a closely held company with goodwill, customer relationships, or illiquid assets, an independent valuation is inexpensive insurance against a Canada Revenue Agency challenge years later. If the freeze value is set too low, the Canada Revenue Agency can assert that value was transferred to the new common shareholders as a benefit or a gift; if it is set too high, the freezor's deemed gain on death — the very thing the freeze was meant to cap — is larger than it needed to be.
Price-adjustment clauses
Because valuation is an estimate, a well-drafted freeze includes a price-adjustment clause. This is a provision in the freeze documents stating that if the Canada Revenue Agency later determines the fair market value of the frozen shares was different from the value used, the redemption amount of the preferred shares adjusts automatically to the corrected figure. The Canada Revenue Agency accepts bona fide price-adjustment clauses, provided they reflect a genuine attempt to fix fair market value and the parties agree to be bound by the adjustment. A price-adjustment clause does not excuse a careless valuation, but it provides a safety net that converts a valuation error from a tax disaster into a mechanical correction.
The family trust and the growth shares
Most freezes do not simply hand the new common shares to the children directly. Instead, the growth shares are usually subscribed for by a discretionary family trust, for a nominal amount, at the moment of the freeze. The trust holds the future growth on behalf of a class of beneficiaries — typically the founder's children and grandchildren, and sometimes the founder's spouse and the founder. This adds flexibility that direct ownership cannot: the trustees decide, year by year, which beneficiaries receive distributions; the trust can be used to multiply the lifetime capital gains exemption across several beneficiaries on a future sale of qualified small business corporation shares; and the founder, if named as a trustee, can retain a measure of control over the growth shares even though the value of that growth no longer accrues to the founder personally.
The trust route carries its own rules that have to be respected. The tax on split income (TOSI) can apply punitive top-rate taxation to dividends paid through a trust to family members who are not actively engaged in the business, subject to a set of exclusions. The 21-year deemed-disposition rule means a trust is treated as disposing of its capital property at fair market value every 21 years, so the trust's holdings have to be reviewed and, if necessary, rolled out to beneficiaries before that anniversary. And the attribution rules can apply where the founder funds the trust in a way that causes income to be attributed back. None of these is a reason to avoid a trust, but each is a reason to design the trust deliberately.
A worked example: a $4 million operating company
Suppose a founder owns all the common shares of an operating company now worth $4 million, with a nominal cost base. If the founder died today, the deemed disposition under subsection 70(5) would produce a roughly $4 million capital gain. If the company doubles in value over the next decade, that deemed gain doubles too — and so does the tax. A freeze stops that clock. The founder exchanges the common shares for preferred shares with a fixed redemption value of $4 million (using a section 86 reorganization, or a section 85 transfer into a new holdco), and a family trust subscribes for new common shares for a nominal amount. From that day forward, the founder's deemed gain on death is capped at $4 million regardless of how the business grows; the next $4 million of growth accrues to the trust's common shares, in the hands of the next generation. The founder can continue to draw dividends on the preferred shares and, if the preferred shares are voting, can keep control of the company. A price-adjustment clause backs up the $4 million figure in case the Canada Revenue Agency later disputes the valuation.
Common questions about estate freezes
Can I undo or adjust a freeze later? Yes. If the business value falls after a freeze, a "refreeze" can reset the preferred-share value down to the new, lower fair market value, reducing the deemed gain that will arise on death. Refreezing is one reason the original freeze should be documented with later moves in mind.
Does a freeze mean I lose control of my company? Not necessarily. The freeze fixes the value of the founder's interest; it does not have to surrender voting control. Voting can be attached to the preferred (freeze) shares, so the founder keeps control while the economic growth shifts to the new common shares.
When is the best time to freeze? The freeze is most valuable when the business still has substantial growth ahead of it, because everything that comes after the freeze date accrues outside the founder's estate. A freeze done after most of the growth has already happened still caps further appreciation, but it captures less of the benefit.
Common pitfalls
Freezes go wrong in predictable ways: preferred shares drafted without the fixed redemption value, retraction right, and ranking needed to actually freeze the value; articles that do not authorize the new share classes before they are issued; a valuation that cannot be supported and no price-adjustment clause to fall back on; family-trust mechanics that overlook the tax on split income rules or the 21-year deemed disposition; and a failure to plan the eventual thaw — how and when the frozen value will ultimately be redeemed or extracted, and the interaction with sections 84.1 and 55. A freeze is the first move in a long game, and it should be documented with the later moves in mind.
If you are considering an estate freeze, or revisiting one that was put in place years ago and may need a refreeze, Barrett Tax Law can help you choose the technique, set the structure, and prepare the documentation. The first consultation focuses on your objectives and the realistic options for your corporation and family.