Much of Canadian tax and estate planning depends on being able to move assets or rearrange shares without triggering an immediate tax bill. Three provisions of the Income Tax Act make that possible: section 85, section 86, and section 51. They are the engines behind estate freezes, incorporations, purifications, and corporate reorganizations. They look similar at a glance — each defers a capital gain that would otherwise arise — but each does a distinct job, and choosing the right one matters.
Section 85: transferring assets to a corporation
A section 85 rollover allows a taxpayer to transfer eligible assets to a corporation in exchange for shares without immediate tax repercussions. Its purpose is to defer the recognition of a capital gain when assets are moved into a corporation, which makes it the workhorse provision for business structuring and reorganization.
The provision is versatile. It is used to incorporate a sole proprietorship (transferring the assets of an unincorporated business into a new corporation while deferring the gain), to move personally held real estate into a corporation for liability protection, to protect assets by transferring them to a corporation, to transfer assets from a family trust to a corporation as part of a succession plan, to roll a partnership's assets into a corporation, to reorganize assets within a corporate group, to split different business lines into separate corporations, and to carry out estate freezes, succession transfers, and intergenerational transfers.
Several conditions must be met for the rollover to apply:
- A joint election. The transferor and the corporation must jointly elect for the rollover, using Form T2057 ("Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation"). The form is filed with the taxpayer's income tax return for the year of the transfer; late filing is possible but attracts penalties.
- Share consideration. The consideration the transferor receives must include shares of the corporation.
- The elected amount. The jointly agreed elected amount must fall between the asset's adjusted cost base and its fair market value. That elected amount determines the new cost base of the transferred asset to the corporation and the cost base of the shares the transferor receives.
- Canadian residence. Both the transferor and the corporation must be Canadian residents.
The assets eligible for a section 85 rollover include most capital property, depreciable property, and eligible capital property — real estate, machinery, and intellectual property among them.
Section 86: reorganizing capital within one corporation
Section 86 permits a reorganization of capital, enabling a shareholder to exchange shares of one class for shares of another class in the same corporation without immediate tax implications. From the planning perspective, it is most often seen in the estate-freeze context — it is section 86 that lets a shareholder convert common shares (which carry the current value and future growth) into fixed-value preferred shares, after which new common shares are issued to the next generation or a family trust to capture future growth. Our estate freeze guide shows that sequence in action.
The tax-deferral mechanism works by carrying the adjusted cost base and paid-up capital of the original shares over to the new shares, so the inherent gain is deferred until the new shares are ultimately disposed of. For the rollover to apply, the taxpayer must exchange all the shares of a particular class for shares of another class in the same corporation, and must not receive consideration other than the new shares (receiving "boot" — a small amount of cash or other property — can complicate the rollover and trigger immediate tax consequences). Unlike a section 85 transfer, the section 86 reorganization is automatic when the conditions are met, rather than depending on a joint election.
Section 51: converting securities within one corporation
Section 51 deals with the conversion of one class of shares into another class of the same corporation, allowing a taxpayer to exchange shares for other shares of the same corporation without immediately triggering a capital gain. It is narrower than section 86 and is typically used to consolidate different classes of shares into a single class, or to change the rights attached to existing shares, as part of a corporate reorganization.
The requirements are specific: the transaction must be an exchange of shares for other shares (not for other property or consideration); the shares received must be from the same corporation; the corporation must be resident in Canada; and the exchanged shares must represent a continuation of the taxpayer's investment, so the taxpayer's proportional interest is not significantly altered. As with section 86, the adjusted cost base of the old shares carries over to the new shares, and the gain is deferred until the new shares are disposed of.
The provisions side by side
The three provisions are easiest to keep straight by their core purpose:
- Section 85(1) — transfer of assets to a corporation in exchange for shares. Requires a joint election on Form T2057. Used for incorporations, asset protection, purifications, and estate freezes run through a holding company. The elected amount (between cost base and fair market value) sets the new cost base.
- Section 86 — reorganization of capital: exchange of all shares of one class for shares of another class in the same corporation. Used for internal capital reorganizations and the classic in-place estate freeze. The aggregate cost base of the old shares becomes the cost base of the new shares.
- Section 51 — conversion of securities: exchange of shares for other shares of the same corporation. Used to consolidate share classes or alter share rights while preserving the taxpayer's proportional investment.
Tax legislation and administrative guidance evolve, and the appropriateness and execution of any rollover depend on the specific facts, so these provisions are tools to be applied with care rather than templates. Used correctly, they let an owner restructure a business, freeze an estate, or prepare for a sale without an immediate tax cost — which is why they sit at the centre of so much Canadian tax and estate planning.
This guide draws on Dale Barrett's book Holistic Tax & Estate Planning.