Section 85 Rollover vs Capital Gains Reserve for Selling a $2M Ontario Business to an Adult Child in 2026: Which Election Defers More Tax and When CRA Claws It Back
Key Takeaways
- 1Understanding section 85 rollover vs capital gains reserve for selling a $2m ontario business to an adult child in 2026: which election defers more tax and when cra claws it back is crucial for financial success
- 2Professional guidance can save thousands in taxes and fees
- 3Early planning leads to better outcomes
- 4GTA residents have unique considerations for business sale planning
- 5Taking action now prevents costly mistakes later
Quick Summary
This article covers 5 key points about key takeaways, providing essential insights for informed decision-making.
Quick Answer
For an Ontario business owner transferring $2M of qualifying small business corporation (QSBC) shares (ACB $200K) to an adult child, a Section 85 rollover with the elected amount set at $1.45M crystallizes the parent’s $1.25M Lifetime Capital Gains Exemption, producing $0 of immediate tax. The child inherits the shares with an ACB of $1.45M and $550K of embedded gain. The capital gains reserve alternative — selling the shares at $2M with a 10-year instalment note — spreads the $550K of non-exempt gain into $55K/year, taxed at roughly $14,700/year in Ontario (50% inclusion, ~$27,500 taxable, marginal rate around 44%). Over 10 years that totals ~$147,000 of tax paid by the parent. The Section 85 path defers that $147,000 entirely to the child’s future sale, but if the child sells the shares before building up their own LCGE room, they’ll owe ~$174,000 on the $550K gain at the tiered 50%/66.67% inclusion rate. The decision turns on two variables: whether the child plans to hold the shares long-term, and whether the parent might die before the reserve period ends (which accelerates all unreserved gain into the terminal return).
Key Takeaways
- 1Section 85 of the Income Tax Act lets a parent transfer QSBC shares to a child’s corporation (or to the child directly via s. 85.1 share-for-share exchange) at any elected amount between the ACB ($200K) and FMV ($2M). Setting the elected amount at $1.45M — ACB plus the $1.25M LCGE — crystallizes the full exemption at $0 tax and gives the child an ACB of $1.45M.
- 2The capital gains reserve under section 40(1)(a) of the ITA, extended to 10 years for intergenerational QSBC transfers under s. 40(1.1), lets the parent spread the $1.8M gain over a decade. After claiming the $1.25M LCGE, the remaining $550K of gain is recognized at $55K/year. At Ontario marginal rates, total tax over 10 years is approximately $147,000.
- 3If the parent dies mid-reserve, all unreserved capital gain is included on the terminal T1 return under section 72(2) of the ITA. Five years into a 10-year reserve with $275K of gain still deferred, the terminal return adds $275K of capital gains — pushing the estate into Ontario’s top 53.53% bracket and producing roughly $93,000 of tax in a single year.
- 4The child’s future tax liability depends on their ACB. Under the Section 85 path (ACB $1.45M), a future $2M sale triggers $550K of gain and ~$174,000 of tax. Under the reserve path, the child’s ACB is the full $2M purchase price — meaning $0 tax on a future sale at the same value. The reserve costs the parent $147,000 but saves the child $174,000.
- 5The 2026 LCGE on QSBC shares is approximately $1.25M (indexed annually since the 2024 federal budget). The three-test QSBC qualification — 90% active business assets at sale, 50%+ for 24 months prior, shares held by the individual for 24+ months — must be confirmed before either election. Failing QSBC status on a $2M transfer costs roughly $376,000 in capital gains tax.
Quick Summary
This article covers 5 key points about key takeaways, providing essential insights for informed decision-making.
The Business We're Modelling: $2M Ontario QSBC, ACB $200K
A 62-year-old Mississauga business owner wants to transfer her incorporated consulting practice to her 34-year-old son. The numbers:
- Fair market value of shares: $2,000,000
- Adjusted cost base (ACB): $200,000
- Accrued capital gain: $1,800,000
- Parent's remaining LCGE room: ~$1,250,000 (full 2026 exemption, never previously claimed)
- Province of residence: Ontario (top combined marginal rate: 53.53%)
- QSBC status: confirmed (90% active business assets, 50%+ for 24 months, shares held 12+ years)
The $1.8M embedded gain is the tax problem. Without any election, selling these shares triggers capital gains tax that can reach $376,000+ at Ontario's top rate. Two ITA provisions offer different paths to defer or reduce that bill: Section 85 (tax-deferred rollover) and Section 40(1)(a)/(1.1) (capital gains reserve spread over 10 years for intergenerational QSBC transfers).
QSBC qualification is the entire gate
Both paths require the shares to qualify as QSBC. The three tests under section 110.6(1) of the ITA: (1) 90% of corporate assets used in active business at the time of transfer, (2) more than 50% of assets used in active business for the 24 months before transfer, and (3) shares held by the individual for at least 24 months. Excess retained earnings or passive investments inside the corporation can blow the 90% test. A Mississauga bookkeeping practice owner we've profiled before had to pay out a dividend 18 months before selling just to restore QSBC eligibility.
Path 1: Section 85 Rollover With LCGE Crystallization
Section 85 of the Income Tax Act allows the parent to transfer shares to a corporation controlled by the child at a jointly-elected price between the ACB ($200K) and FMV ($2M). The elected amount determines how much gain the parent recognizes immediately and what ACB the child's corporation receives.
Choosing the elected amount: the LCGE sweet spot
The optimal elected amount for a parent with full LCGE room is $1,450,000— the ACB ($200K) plus the $1.25M LCGE. Here's why:
| Elected amount | Gain recognized | LCGE claimed | Tax payable | Child's ACB |
|---|---|---|---|---|
| $200K (ACB) | $0 | $0 (wasted) | $0 | $200K |
| $1.45M (optimal) | $1.25M | $1.25M | $0 | $1.45M |
| $2M (FMV) | $1.8M | $1.25M | ~$147K | $2M |
Electing at $200K wastes the LCGE entirely — the parent recognizes no gain, so there's nothing to shelter. Electing at FMV ($2M) forces the parent to pay tax on the $550K excess over the LCGE. The $1.45M sweet spot crystallizes the full LCGE at zero tax and gives the child the highest possible ACB without the parent paying a dollar.
What the child inherits: $550K of embedded gain
After the Section 85 transfer at $1.45M, the child's corporation holds shares with an ACB of $1.45M and FMV of $2M. If the child later sells for $2M:
- Capital gain: $2,000,000 − $1,450,000 = $550,000
- First $250K at 50% inclusion: $125,000 taxable
- Remaining $300K at 66.67% inclusion: $200,000 taxable
- Total taxable capital gain: $325,000
- At Ontario's top marginal rate of 53.53%: ~$174,000 tax
That $174,000 is the child's problem, not the parent's. If the child holds the shares long-term and the business appreciates, the $550K embedded gain becomes a smaller percentage of the total value. And if the child qualifies for their own LCGE at the time of their eventual sale (the shares must still meet QSBC tests), up to $1.25M of their gain is sheltered too.
Section 85 summary: parent pays $0 now, child carries $550K of future gain
Total family tax deferred: approximately $174,000 (the child's future liability on the $550K embedded gain). The parent's $1.25M LCGE is fully consumed. No annual tax filings triggered by the election itself beyond the T2057 form filed with the transfer-year return.
Path 2: Capital Gains Reserve — 10-Year Instalment Sale
Instead of a tax-deferred rollover, the parent sells the shares to the child at full FMV ($2M) and takes back a 10-year promissory note. Section 40(1)(a) of the ITA allows the parent to claim a capital gains reserve, recognizing the gain only as payments are received. For intergenerational transfers of QSBC shares, section 40(1.1) extends the maximum reserve period from 5 to 10 years.
Year-by-year tax math
Total capital gain: $1,800,000. LCGE claimed in year 1: $1,250,000. Remaining gain subject to reserve: $550,000. Minimum recognition: 10% per year = $55,000/year over 10 years.
| Year | Gain recognized | Taxable (50% inclusion) | Approx. Ontario tax | Cumulative tax paid |
|---|---|---|---|---|
| Year 1 | $55,000 | $27,500 | ~$12,100 | $12,100 |
| Year 3 | $55,000 | $27,500 | ~$12,100 | $36,300 |
| Year 5 | $55,000 | $27,500 | ~$12,100 | $60,500 |
| Year 7 | $55,000 | $27,500 | ~$12,100 | $84,700 |
| Year 10 | $55,000 | $27,500 | ~$12,100 | ~$121,000 |
The tax estimate assumes the $55K annual gain is the parent's only capital gain each year, keeping all of it within the 50% inclusion tier (under $250K). If the parent has other capital gains pushing total annual gains above $250K, the 66.67% tier kicks in and the annual tax increases. The parent's other income also affects the marginal rate — $27,500 of additional taxable income at a 44% marginal rate produces ~$12,100, but at the top 53.53% rate it's ~$14,700. Over 10 years, the total ranges from $121,000 to $147,000.
The child's position: ACB of $2M, $0 embedded gain
Under the reserve path, the child buys at FMV. Their ACB is the full $2,000,000. If they later sell the business for $2M, there is no capital gain and no tax. Even if the business appreciates to $3M before the child sells, the child's gain starts from $2M — not from $200K or $1.45M as it would under the Section 85 path.
Reserve summary: parent pays ~$121K–$147K over 10 years, child carries $0 embedded gain
The parent pays real tax, but it's spread into manageable annual instalments. The child starts clean with a $2M ACB. If the child plans to sell the business within a few years (before building LCGE room), the reserve path saves the family $27,000–$53,000 overall compared to Section 85.
Side-by-Side: Total Family Tax Under Each Path
| Metric | Section 85 (elected at $1.45M) | Capital gains reserve (10-year) |
|---|---|---|
| Parent's immediate tax | $0 | ~$12,100/yr × 10 = $121K–$147K |
| Parent's LCGE used | $1.25M (fully consumed) | $1.25M (fully consumed) |
| Child's ACB | $1,450,000 | $2,000,000 |
| Child's embedded gain | $550,000 | $0 |
| Child's tax on future $2M sale | ~$174,000 | $0 |
| Total family tax (parent + child) | $0 + $174K = $174,000 | $121K–$147K + $0 = $121K–$147K |
| Family tax saving | — | $27K–$53K less total tax |
Wait — the reserve path costs less overall? Yes, if the child sells at $2M. The parent pays $121K–$147K spread over 10 years (time-value advantage), and the child pays $0. Under Section 85, the parent pays $0 but the child eventually owes $174K. The reserve path saves the family $27K–$53K in total tax. But there's a catch: the child has to actually pay $2M (via the promissory note), and the parent has to survive 10 years to get the full benefit of the reserve spread.
The Post-Mortem Trap: Parent Dies Mid-Reserve
This is where the capital gains reserve can backfire catastrophically. Under section 72(2) of the ITA, all unreserved capital gain is included on the deceased's terminal T1 return. The reserve does not transfer to the estate, the executor, or the child. It dies with the taxpayer.
Worked example: parent dies in year 5
- Gain recognized in years 1–5: $55,000 × 5 = $275,000 (tax already paid: ~$60,500)
- Unreserved gain remaining: $275,000
- Added to terminal return as capital gain
- At 50% inclusion (assuming under $250K): $137,500 taxable
- At Ontario's top marginal rate of 53.53%: ~$73,600 of tax on the terminal return
Total tax paid by the parent: $60,500 (years 1–5) + $73,600 (terminal return) = $134,100. That's slightly less than the full 10-year total of $121K–$147K, but the terminal-return hit is concentrated in a single year, stacking on top of any other income on the final return (RRIF inclusion, other gains from deemed disposition at death). If the parent also had a $500K RRIF, the combined terminal return income could push well past $500K, with most of it taxed at 53.53%.
The reserve is a bet on the parent's longevity
A 62-year-old Ontario woman has a life expectancy of roughly 86. A 10-year reserve starting at 62 expires at 72 — well within her expected lifespan. But health flags change the calculus entirely. If there's a meaningful probability of death within the reserve period, Section 85 is the safer election: the parent recognizes $0 tax regardless of when they die, and the child's ACB is locked at $1.45M. The terminal return never includes a reserve clawback because no reserve was ever claimed.
The Instalment-Sale Risk: What If the Child Sells Early?
Under the capital gains reserve path, the child has an ACB of $2M and a $2M promissory note payable to the parent. If the child decides to sell the business three years in — say a competitor offers $2.5M — two things happen:
- The child's sale: $2.5M − $2M ACB = $500K gain. Tax at the tiered 50%/66.67% rate: ~$158,000. But the child still owes 7 years of payments on the promissory note to the parent.
- The parent's reserve: The reserve is based on the proceeds not yet due from the child. If the child pays off the promissory note early (using the $2.5M sale proceeds), the reserve collapses — the parent must recognize the remaining deferred gain in the year the note is satisfied. Seven years of deferred gain ($385K) lands on a single return.
Under Section 85, the same scenario is simpler: the child sells for $2.5M, recognizes a $1.05M gain ($2.5M − $1.45M ACB), and claims their own LCGE if the shares still qualify as QSBC. If the child has full LCGE room ($1.25M), the entire $1.05M gain is sheltered — $0 tax. That's the scenario where Section 85 dramatically outperforms the reserve.
What If the Parent Has Already Used Some LCGE?
The analysis above assumes the parent has the full $1.25M LCGE available. If the parent previously claimed LCGE on another disposition (a prior business sale, farm property, etc.), the remaining room changes the math:
| Remaining LCGE | S.85 elected amount | Parent's tax | Child's embedded gain | Reserve alternative: parent's 10-yr tax |
|---|---|---|---|---|
| $1.25M (full) | $1.45M | $0 | $550K | $121K–$147K |
| $750K (partial) | $950K | $0 | $1.05M | $231K–$282K |
| $0 (exhausted) | $200K (ACB) | $0 | $1.8M | $376K+ |
With zero LCGE remaining, Section 85 at ACB defers the entire $1.8M gain to the child. The reserve path forces the parent to pay $376K+ over 10 years. The less LCGE the parent has, the more the Section 85 deferral is worth — and the more the reserve costs. This is exactly why estate freezes done at age 60–65 are so valuable: they lock in the LCGE early, when the business value is lower and the full exemption is still available.
Decision Matrix: Which Election Wins?
The right answer depends on three variables: the child's ability to pay, the parent's remaining LCGE, and the parent's health profile. Here's the decision framework:
| Scenario | Recommended election | Why |
|---|---|---|
| Child plans to hold long-term (>10 years), parent has full LCGE | Section 85 at $1.45M | Parent pays $0. Child builds own LCGE room over time. Maximum deferral. |
| Child may sell within 5 years, parent has full LCGE and is healthy | Capital gains reserve | Gives child $2M ACB. Parent pays ~$121K–$147K spread over 10 years. Family saves $27K–$53K vs Section 85. |
| Parent has health concerns or is 70+ | Section 85 at optimal LCGE amount | Eliminates post-mortem reserve clawback risk. No terminal-return surprise. |
| Parent has exhausted LCGE | Section 85 at ACB ($200K) | Maximum deferral. $1.8M gain shifts to child, who may build their own LCGE. |
| Child can't fund a promissory note (no external financing) | Section 85 | Reserve requires an actual sale at FMV with real consideration. Section 85 has no cash-flow requirement. |
| Parent wants retirement income from the sale | Capital gains reserve | The promissory note provides $200K/year of cash flow. Tax is manageable at $12K–$15K/year on the gain portion. |
Estate Planning Implications: What Happens at the Parent's Death Under Each Path
Beyond the reserve clawback, the parent's death triggers different estate outcomes depending on which election was used:
Section 85 path: clean estate
- The shares are already in the child's hands. No deemed disposition on the parent's terminal return for these shares.
- Parent's estate includes whatever consideration was received (typically preferred shares or a nominal amount). If preferred shares, deemed disposition applies to those.
- No outstanding promissory note to deal with in estate administration.
- Ontario probate applies only to assets still in the parent's estate. The transferred business shares are excluded.
Reserve path: promissory note in the estate
- The outstanding balance on the promissory note is an asset of the parent's estate. On a $2M note with $1.4M still owing, that $1.4M is subject to Ontario probate at 1.5% = $21,000 of probate fees.
- All unreserved gain is included on the terminal return (the section 72(2) acceleration discussed above).
- The child still owes the remaining payments. If the child can't pay, the estate holds a potentially uncollectable receivable — and has already paid tax on the gain associated with it.
- The executor must obtain a CRA clearance certificate before distributing — section 159 of the ITA makes the executor personally liable for tax shortfalls.
The reserve creates a more complex estate
If minimizing estate administration complexity is a priority — especially for blended families or executors who are not tax-savvy — the Section 85 path produces a cleaner post-mortem result. The trust structure analysis for high-net-worth estates covers additional tools (estate freeze with preferred shares, spousal trusts) that can be layered onto the Section 85 transfer.
What About an Estate Freeze Instead?
Both Section 85 and the capital gains reserve assume the parent is transferring ownership now. An estate freeze is the third option — the parent keeps control via fixed-value preferred shares, the child subscribes for new common shares at nominal cost, and future growth accrues to the child. The parent's exposure is frozen at today's $2M FMV.
The freeze doesn't eliminate the parent's $1.8M embedded gain — it just stops it from growing. At the parent's death, the preferred shares trigger deemed disposition on $1.8M of gain. But the LCGE shelters $1.25M, leaving $550K taxable on the terminal return. The advantage over the reserve: no mid-life tax payments, no promissory note, and the parent retains full operational control until death or voluntary redemption.
A BC professional corporation case study walks through the estate freeze mechanics in detail, including the preferred-share redemption strategy and the interaction with corporate purification for QSBC eligibility.
Bottom Line: The One Variable That Decides Everything
For most Ontario business owners transferring QSBC shares to an adult child, Section 85 with the elected amount set at ACB + remaining LCGE is the right starting point. It produces $0 immediate tax, crystallizes the parent's LCGE, eliminates post-mortem reserve risk, and gives the child the highest possible ACB without the parent paying anything.
The capital gains reserve wins on total family tax if — and only if — the child plans to sell the business relatively quickly (within 5–10 years) and the parent is healthy enough to survive the reserve period. If both conditions hold, the reserve saves the family $27K–$53K versus Section 85 on a $2M transfer. But if either condition fails — the child holds long-term and builds their own LCGE, or the parent dies mid-reserve — Section 85 produces the better outcome.
The one variable that decides everything: does the child plan to keep the business, or flip it? Keepers get Section 85. Flippers get the reserve. Everyone else gets an estate freeze and a conversation with a tax accountant who works with intergenerational business transfers — not a generalist, but someone who files section 85 elections routinely and understands the QSBC purification requirements.
Frequently Asked Questions
Q:What is a Section 85 rollover in Canada?
A:Section 85 of the Income Tax Act allows a taxpayer to transfer eligible property (including QSBC shares) to a Canadian corporation on a tax-deferred basis. The transferor and the corporation jointly elect a transfer price (the “elected amount”) between the property’s adjusted cost base and its fair market value. The transferor recognizes a capital gain only to the extent the elected amount exceeds the ACB. The receiving corporation takes the property at the elected amount as its new cost base. This mechanism is commonly used in estate freezes and intergenerational business transfers.
Q:How long can a capital gains reserve be spread for transfers to a child?
A:The standard capital gains reserve under section 40(1)(a) of the ITA allows spreading a gain over up to 5 years (minimum 20% recognized per year). However, section 40(1.1) extends this to 10 years (minimum 10% per year) for intergenerational transfers of qualifying small business corporation shares, family farm property, or family fishing property to a child, grandchild, or great-grandchild. The child must be a resident of Canada at the time of transfer.
Q:What is the Lifetime Capital Gains Exemption (LCGE) for 2026?
A:The 2026 LCGE on qualifying small business corporation (QSBC) shares is approximately $1.25M, indexed annually for inflation following the 2024 federal budget. This exemption shelters capital gains realized on the disposition of QSBC shares from tax entirely. The three tests for QSBC qualification are: (1) 90% of corporate assets used in active business at the time of sale, (2) more than 50% of assets used in active business for the 24 months preceding the sale, and (3) shares held by the individual (not a holding company) for at least 24 months.
Q:What happens to a capital gains reserve if the seller dies?
A:Under section 72(2) of the Income Tax Act, any unreserved capital gain is included on the deceased’s terminal T1 return. If a parent is five years into a 10-year reserve with $275,000 of gain still deferred, the full $275,000 is added to the terminal return. At Ontario’s top combined marginal rate of 53.53%, this produces roughly $93,000 of additional tax in a single year. The reserve does not transfer to the estate or the child — it dies with the taxpayer.
Q:Can you use the LCGE with a capital gains reserve?
A:Yes. The LCGE is claimed against the total capital gain realized, and the reserve then applies to the remaining non-exempt portion. On a $1.8M gain from selling QSBC shares, you claim the $1.25M LCGE first, reducing the taxable gain to $550K. The 10-year reserve then spreads that $550K into annual inclusions of $55K. You do not need to wait until the end of the reserve to claim the LCGE — it applies in the year of disposition.
Q:What is the capital gains inclusion rate in Canada for 2026?
A:For individuals, the first $250,000 of annual capital gains is included at 50% (so $125,000 is taxable). Capital gains above $250,000 in a single year are included at 66.67% (two-thirds). For corporations and trusts, the 66.67% inclusion rate applies to all capital gains from the first dollar. This tiered structure was introduced in the 2024 federal budget, effective June 25, 2024.
Q:What risks does the child face if they sell the business shortly after a Section 85 transfer?
A:If the child sells the shares shortly after receiving them via Section 85, they face capital gains tax on the difference between their ACB (the elected amount) and the sale price. With an elected amount of $1.45M and a $2M sale, the child realizes a $550K gain. At the tiered 50%/66.67% inclusion rate: $250K × 50% = $125K + $300K × 66.67% = $200K = $325K taxable. At Ontario’s top rate of 53.53%, tax is approximately $174,000. The child may have their own LCGE room, but only if the shares still qualify as QSBC at the time of their sale.
Q:How does an estate freeze differ from a Section 85 rollover?
A:An estate freeze uses Section 85 as the mechanism, but the goal is different. In a freeze, the parent transfers common shares to a holding company in exchange for fixed-value preferred shares (freezing their value at current FMV) and the child subscribes for new common shares at nominal cost. Future growth accrues to the child’s common shares. A direct Section 85 transfer, by contrast, moves existing shares to the child at a chosen elected amount. Both use section 85 of the ITA, but the freeze locks in the parent’s exposure while the direct transfer moves it.
Question: What is a Section 85 rollover in Canada?
Answer: Section 85 of the Income Tax Act allows a taxpayer to transfer eligible property (including QSBC shares) to a Canadian corporation on a tax-deferred basis. The transferor and the corporation jointly elect a transfer price (the “elected amount”) between the property’s adjusted cost base and its fair market value. The transferor recognizes a capital gain only to the extent the elected amount exceeds the ACB. The receiving corporation takes the property at the elected amount as its new cost base. This mechanism is commonly used in estate freezes and intergenerational business transfers.
Question: How long can a capital gains reserve be spread for transfers to a child?
Answer: The standard capital gains reserve under section 40(1)(a) of the ITA allows spreading a gain over up to 5 years (minimum 20% recognized per year). However, section 40(1.1) extends this to 10 years (minimum 10% per year) for intergenerational transfers of qualifying small business corporation shares, family farm property, or family fishing property to a child, grandchild, or great-grandchild. The child must be a resident of Canada at the time of transfer.
Question: What is the Lifetime Capital Gains Exemption (LCGE) for 2026?
Answer: The 2026 LCGE on qualifying small business corporation (QSBC) shares is approximately $1.25M, indexed annually for inflation following the 2024 federal budget. This exemption shelters capital gains realized on the disposition of QSBC shares from tax entirely. The three tests for QSBC qualification are: (1) 90% of corporate assets used in active business at the time of sale, (2) more than 50% of assets used in active business for the 24 months preceding the sale, and (3) shares held by the individual (not a holding company) for at least 24 months.
Question: What happens to a capital gains reserve if the seller dies?
Answer: Under section 72(2) of the Income Tax Act, any unreserved capital gain is included on the deceased’s terminal T1 return. If a parent is five years into a 10-year reserve with $275,000 of gain still deferred, the full $275,000 is added to the terminal return. At Ontario’s top combined marginal rate of 53.53%, this produces roughly $93,000 of additional tax in a single year. The reserve does not transfer to the estate or the child — it dies with the taxpayer.
Question: Can you use the LCGE with a capital gains reserve?
Answer: Yes. The LCGE is claimed against the total capital gain realized, and the reserve then applies to the remaining non-exempt portion. On a $1.8M gain from selling QSBC shares, you claim the $1.25M LCGE first, reducing the taxable gain to $550K. The 10-year reserve then spreads that $550K into annual inclusions of $55K. You do not need to wait until the end of the reserve to claim the LCGE — it applies in the year of disposition.
Question: What is the capital gains inclusion rate in Canada for 2026?
Answer: For individuals, the first $250,000 of annual capital gains is included at 50% (so $125,000 is taxable). Capital gains above $250,000 in a single year are included at 66.67% (two-thirds). For corporations and trusts, the 66.67% inclusion rate applies to all capital gains from the first dollar. This tiered structure was introduced in the 2024 federal budget, effective June 25, 2024.
Question: What risks does the child face if they sell the business shortly after a Section 85 transfer?
Answer: If the child sells the shares shortly after receiving them via Section 85, they face capital gains tax on the difference between their ACB (the elected amount) and the sale price. With an elected amount of $1.45M and a $2M sale, the child realizes a $550K gain. At the tiered 50%/66.67% inclusion rate: $250K × 50% = $125K + $300K × 66.67% = $200K = $325K taxable. At Ontario’s top rate of 53.53%, tax is approximately $174,000. The child may have their own LCGE room, but only if the shares still qualify as QSBC at the time of their sale.
Question: How does an estate freeze differ from a Section 85 rollover?
Answer: An estate freeze uses Section 85 as the mechanism, but the goal is different. In a freeze, the parent transfers common shares to a holding company in exchange for fixed-value preferred shares (freezing their value at current FMV) and the child subscribes for new common shares at nominal cost. Future growth accrues to the child’s common shares. A direct Section 85 transfer, by contrast, moves existing shares to the child at a chosen elected amount. Both use section 85 of the ITA, but the freeze locks in the parent’s exposure while the direct transfer moves it.
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