What Is an Estate Freeze and How Does It Work?

An estate freeze is a strategy used to lock in the current value of an individual’s assets for tax and succession planning. This helps manage future tax liabilities while allowing asset growth to benefit heirs or designated successors. It is commonly used by business owners and individuals with appreciating assets who want to transfer wealth efficiently.

By structuring an estate freeze properly, individuals can control how their assets are passed on while minimizing tax burdens. Various financial and legal tools are involved in executing this strategy effectively.

Common Entities Involved

Executing an estate freeze requires coordination between multiple parties. The individual initiating the freeze, known as the “freezor,” is typically a business owner or investor looking to transfer future growth to heirs while retaining control over existing assets. This person works with legal and financial professionals to ensure compliance with tax laws and succession planning goals.

Estate planning attorneys draft agreements and corporate documents to formalize the freeze, ensuring compliance with relevant tax regulations such as the Income Tax Act in Canada or the Internal Revenue Code in the U.S. They may also establish trusts or holding companies to provide tax benefits and asset protection.

Accountants and tax specialists assess capital gains tax liabilities, structure transactions to minimize immediate tax consequences, and ensure proper reporting to tax authorities. In the U.S., this may involve compliance with IRS Section 2701, which governs valuation rules for family-controlled entities, while in Canada, Section 86 of the Income Tax Act facilitates share exchanges in corporate freezes.

Trusts and holding companies often manage ownership transition. A family trust can hold new growth shares for beneficiaries, allowing flexible wealth distribution while maintaining centralized control. Holding companies consolidate assets, defer taxes, or facilitate income splitting among family members.

Valuation Approaches

Determining asset value is a key step in an estate freeze, as it establishes the “frozen” value affecting future tax liabilities and succession planning. Several methods assess the worth of a business or investment holdings, each with distinct advantages.

Net Asset Value

The net asset value (NAV) approach calculates a business’s total value by subtracting liabilities from assets. This method is commonly used for asset-heavy businesses, such as real estate companies or holding corporations.

For example, if a company owns real estate worth $5 million, equipment valued at $1 million, and cash reserves of $500,000, while carrying $2 million in liabilities, the NAV would be:

(5,000,000 + 1,000,000 + 500,000) – 2,000,000 = 4,500,000

Though straightforward, this method may not fully capture future earning potential. It also requires careful consideration of asset depreciation, fair market value adjustments, and potential tax consequences upon disposition. Tax authorities may scrutinize NAV calculations if they suspect undervaluation to reduce tax liabilities.

Capitalized Earnings

The capitalized earnings method values a business based on its ability to generate future income. This approach is often used for service-based businesses and companies with strong cash flow but limited tangible assets. The valuation is determined by dividing expected annual earnings by a capitalization rate, reflecting industry risk and return expectations.

For instance, if a business generates $500,000 in annual net income and the appropriate capitalization rate is 10%, the valuation would be:

500,000 ÷ 0.10 = 5,000,000

Selecting the right capitalization rate is crucial, as it depends on industry benchmarks, economic conditions, and company-specific risks. A lower rate results in a higher valuation, while a higher rate reduces the estimated worth. Tax authorities may review the chosen rate to ensure it aligns with market conditions. Adjustments for non-recurring expenses, owner compensation, and discretionary spending may be necessary to reflect true earnings potential.

Comparable Market Analysis

The comparable market analysis (CMA) method estimates value by comparing the business or assets to similar entities that have been sold or valued recently. This approach is widely used for competitive industries, real estate, and publicly traded securities.

For example, if a privately held manufacturing company is undergoing an estate freeze, its valuation might be based on recent sales of similar businesses. If comparable companies have sold for an average of five times their annual earnings, and the subject company earns $1 million per year, its estimated value would be:

1,000,000 × 5 = 5,000,000

This method requires reliable market data, which can be challenging for privately held businesses. Industry reports, transaction databases, and professional appraisals help establish a reasonable valuation, but differences in company size, growth potential, and market conditions must be carefully considered. Tax authorities may review selected comparables to verify fair market value.

Share Classes

An estate freeze often involves issuing multiple classes of shares with distinct rights and restrictions. A common approach is exchanging common shares for fixed-value preferred shares, locking in the current value while new common shares capture future appreciation.

Preferred shares typically have a redeemable feature, allowing the holder to be bought out at a predetermined value. They may also carry a cumulative dividend right, ensuring unpaid dividends accumulate over time. However, these shares usually have limited or no voting rights, restricting control over company decisions after transferring growth shares.

New common shares, issued to family members or a trust, hold no immediate value but gain worth as the business or investments grow. These shares typically carry full voting rights, allowing successors to participate in decision-making. If issued to a trust, the trustee can allocate shares to beneficiaries as needed, providing flexibility in succession planning. Shareholder agreements should be structured to prevent unintended dilution or disputes among beneficiaries.

Tax Considerations

Proper structuring of an estate freeze is essential to avoid unintended tax liabilities. One primary concern is triggering capital gains tax when assets are frozen. In Canada and the U.S., transferring shares or business interests at fair market value can result in a deemed disposition, meaning tax authorities may treat the exchange as a sale, even if no cash transaction occurs.

Certain provisions allow for tax-deferred rollovers to mitigate this impact. In Canada, Section 85 of the Income Tax Act enables assets to be transferred into a corporation without immediate tax consequences.

Estate freezes also affect estate tax obligations, particularly in the U.S., where the federal estate tax applies to estates exceeding $13.61 million in 2024. By freezing estate value and shifting future growth to heirs or trusts, individuals may reduce their taxable estate. Grantor trusts, such as intentionally defective grantor trusts (IDGTs), are sometimes used to facilitate this process by allowing the transferor to pay income taxes on behalf of beneficiaries, further reducing estate value over time.

Transfer Arrangements

Transferring ownership interests requires careful planning to align with tax laws and succession goals. Many individuals transfer shares gradually through direct gifts or trusts to maintain flexibility while minimizing immediate tax consequences.

Family trusts commonly hold growth shares, allowing the original owner to retain influence over distributions while protecting assets from creditor claims or family disputes. In some cases, a promissory note is used, where the new shareholders agree to pay for the shares over time. This provides liquidity to the original owner while deferring tax liabilities for the recipients.

Reporting Obligations

Tax authorities require detailed reporting when an estate freeze is executed. In the U.S., individuals may need to file gift tax returns (Form 709) if shares are transferred to family members at below-market value.

In Canada, the CRA requires disclosure of share exchanges under Section 86 of the Income Tax Act, and any deferred tax elections must be properly filed to avoid immediate capital gains recognition. Corporate reorganizations related to an estate freeze may also necessitate T2057 or T2058 elections to defer tax consequences. Non-compliance with these reporting requirements can result in penalties or loss of tax deferral benefits.