The death of a Canadian shareholder who owns private-company shares triggers a sequence of tax events that can produce double or triple taxation if not coordinated. Three named planning strategies — the pipeline, the bump, and the loss carryback — recover most of the tax that would otherwise be lost. The 36-month window starts the day of death.
The problem
Subsection 70(5) of the Income Tax Act deems a Canadian resident to dispose of all their property at fair market value the moment before death. For a private-company shareholder, the deemed disposition triggers a capital gain equal to the appreciation since the cost base — taxed at top capital-gains rates on the terminal T1.
The estate then inherits the shares at the stepped-up FMV. If the heirs want to extract the corporation's cash (to fund the tax bill, to provide cash flow, or to wind up the business), the cash distribution is normally a dividend — taxed AGAIN in the recipient's hands. Without planning, the same dollars are taxed once at the shareholder level (capital gain at death) and again at the corporate level on extraction (dividend at distribution).
The pipeline (Section 84(2) wind-up)
The pipeline strategy uses subsections 84(2), 88(1), and a sequence of corporate moves to convert what would otherwise be a taxable dividend into a return of capital — taxed at zero (against the inherited cost base) or capital-gains rates.
Step-by-step:
- The deceased's shares are inherited by the estate at the stepped-up FMV cost base (the cost base reset under subsection 70(5)).
- The estate forms a new holding corporation ("Holdco") and rolls the inherited shares into Holdco under Section 85, taking back debt of Holdco equal to the inherited cost base.
- Holdco and the original corporation amalgamate (or the original is wound up into Holdco under Section 88(1)).
- The amalgamated corporation pays its cash up to the estate as repayment of the Section-85-created debt. The repayment is a return of capital — no further tax.
Result: the corporation's cash flows to the estate at capital-gains rates (paid at death), not at dividend rates (which would be paid on top). The total tax cost is the original terminal-T1 capital gain, with no second layer.
The timing rule
The pipeline depends on subsection 84(2) characterizing the wind-up distribution as proceeds-of-disposition rather than dividend. CRA practice has historically required at least 12 months between the inheritance and the wind-up, with the corporation conducting a "reasonable level" of business during the intervening period. Most pipelines target a 12-24 month window.
The Section 88(1) bump
When a subsidiary corporation is wound up into its parent (or when a 90%+-owned subsidiary is dissolved), subsection 88(1)(d) lets certain assets of the merged entity have their cost base "bumped" up to FMV. The bump is available on land, depreciable property, and shares of other subsidiaries — but not on inventory, intangibles other than goodwill, or accounts receivable.
For an estate inheriting a private corporation that itself owns appreciated real estate (a holding company with rental properties, for example), the bump can shelter the eventual disposition of the real estate from a substantial capital gain. The bump is in addition to the pipeline benefit — they work together.
The Section 164(6) loss carryback
The simplest of the three strategies. If the deceased's estate triggers a capital loss in its first taxation year — typically by a deliberate share redemption that crystallizes a loss against the inherited high-cost-base shares — subsection 164(6) lets that loss be carried back to the deceased's terminal T1 and applied against the deemed-disposition capital gain.
The carryback effectively negates the terminal-year capital-gains tax to the extent of the loss. Combined with the pipeline (which extracts the cash at zero further tax), the loss-carryback can produce near-complete elimination of the double-tax problem.
Coordinating with the spousal rollover
If the deceased's shares pass to a surviving spouse (or to a qualifying spousal trust), subsection 70(6) automatically rolls the shares over at the deceased's adjusted cost base — deferring the deemed disposition. The spousal rollover is the right answer if the spouse intends to hold the shares; it's the wrong answer if the spouse plans to extract the corporation's cash immediately, because the rollover prevents the cost-base step-up that the pipeline needs.
For a spouse who wants to extract cash but doesn't want to trigger the gain on the entire share value, an election to OPT OUT of the spousal rollover for specific shares (under subsection 70(6.2)) is available. Partial opt-outs let the spouse take some shares at the stepped-up FMV (suitable for immediate pipeline extraction) while leaving the rest at deferred cost base.
The 36-month statutory window
The estate's first taxation year is 12 months from death (with the executor able to choose a shorter year). The 36-month window for graduated-rate-estate (GRE) treatment runs for three years from death. After that, the estate loses GRE status and is taxed at top trust rates on accumulated income. Most post-mortem planning is sized to complete within the 36-month window.
Insurance-funded version
Where the deceased's corporation owned a key-person life-insurance policy on the deceased, the death benefit pays into the corporation's capital dividend account (CDA). The estate can distribute the CDA balance as a tax-free capital dividend — funding the terminal-year capital-gains tax with after-tax-equivalent dollars. Many succession plans use exactly this mechanism.
How we work the file
Post-mortem engagements at Barrett Tax Law typically start within 30-60 days of death and run for 12-24 months. We design the strategy, coordinate the inherited-cost-base documentation with the estate's accountants, implement the Section 85 rollover, structure the wind-up or amalgamation, file the Section 164(6) loss-carryback election, and handle the related T3 and T1 filings. Most engagements are fixed-fee for the planning phase and capped for execution.