Does an estate freeze always need a section 85 or section 86 election?

An estate freeze swaps an owner’s shares for new ones, and the Income Tax Act has more than one rule for share swaps. Of the rules covered here, only section 85 depends on an election; there is no election in section 86. The real question is therefore which rule the freeze is built on, because that decides who controls the tax result and what has to be filed.

What section 85 needs

Section 85 applies when a taxpayer transfers eligible property to a taxable Canadian corporation for consideration that includes shares, and the two jointly elect in the prescribed form, which the CRA publishes as T2057. The amount they agree on becomes the transferor’s proceeds, within limits tied to fair market value and cost, so the election is what lets the parties choose the tax result. Our answer on the section 85 rollover covers the basics.

What section 86 does without one

Section 86 applies when, in a reorganization of a corporation’s capital, a shareholder gives up all the shares of a class and receives other shares of the same corporation. Its rules apply once those conditions are met, and the cost of the new shares is worked out from the old shares’ cost rather than chosen. Subsections 86(1) and 86(2) do not apply where subsection 85(1) or 85(2) applies. Section 51 is a further rule, which does not apply to an exchange covered by section 85(1), 85(2) or 86: where a shareholder takes a new share of a corporation in exchange for another of its shares held as capital property and receives nothing else, the exchange is deemed not to be a disposition of the old share.

Why the route matters

A section 85 election can set the agreed amount anywhere within the permitted range, including above cost, which realizes a gain on purpose. Whether that gain is sheltered depends on the capital gains deduction, which the CRA ties to dispositions of qualified small business corporation shares. An automatic rule gives no such choice. Whichever route is used, the Act tests fair market value, so valuation sits behind every freeze. If the term is new, start with what an estate freeze is.