My first non-COVID post in a while……
This blog has been prompted by some recent changes to the law, plus a few conversations I’ve had these past weeks. In this hot local property market, people are thinking more about investing in real estate. I’m sorry for the length of this post, but it covers some fairly heavy topics.
Part 1 is aimed at Realtors® who have recently gained the right to incorporate their businesses.
Part 2 is aimed at anybody who plans to invest in property (including realtors) and is thinking of using a company to do it. However, please read Part 1 as well… Part 2 won’t make sense without it.
Many people have general questions about how or why your average citizen may use a company – and how it works. If you’re a bit hazy, please may I ask you to read “In Good Company Abridged” before you go further.
In that earlier blog post, I gave a few reasons why a business owner may consider incorporating what they do (and this applies to self-employed professionals as well as anybody else). In brief, they were: some legal protection; credibility-of-business issues; and tax advantages.
I glossed over the tax points that time – partly to keep it simple, and also because the rules were changing, at the time of writing.
However…. the tax stuff keeps bubbling back up. It was also the main driver behind the change in the law affecting realtors. So this blog post will delve a little deeper into the tax side of that. But don’t worry, I’ll try to keep it in plain English.
Realtors have been asking for the right to incorporate for some time. After all, Ontario accountants, doctors, chiropractors and others already have it…. now realtors do too. Their new corporations will be known as PRECs, or Personal Real Estate Corporations. [I find this name is very confusing – it suggests that PRECs are available to anybody who wants to invest in real estate. They’re not. I’ve already had calls on this.]
This LINK gives you the news release from their professional body. It gives a fairly good summary and is technically accurate.
What this change will NOT do…
- It will not allow a realtor to claim more writeoffs.
- If a realtor takes all his/her money out of the corporation, it will not save taxes. Discussed below.
- It doesn’t suddenly open the door to being able to put spouse, kids etc. on payroll or pay them dividends.
- It won’t ultimately reduce the amount of tax a realtor pays on investment income. Discussed in Part 2 below.
- Despite the name, it’s FAR FROM CLEAR that a realtor can hold real estate in his or her PREC – and I know many realtors who want to do this. After all, it’s your area of expertise! (This may receive further clarification…..) [FOOTNOTE*] However, there is a loophole….
So why would you incorporate? There are three possible reasons:
- It opens the door for a realtor to pay him/herself by dividends, thus avoiding upto about $5,500 in CPP contributions each year. As a rule, I do not recommend this. This route saves you the CPP contributions – but you’ll damage the CPP benefits you ultimately receive, and dividends do NOT help you build up RRSP contribution headroom. You can still have a corporation and pay yourself a salary, which will require you to pay CPP.
- Incorporation does open the door to one of the few remaining “free lunches” in the Canadian tax system: the ability to sell your book of business via sale of your corporation, and claim your Lifetime Capital Gains Exemption [LGCE]. This lets you legally avoid tax on the first nearly-$900k or so of any surplus on the sale. Remains to be seen how often this will result in a big gain, or if a buying realtor will be prepared to acquire your corporation.
- Here’s the big one, and the reason why OREA was pushing for it: tax deferral on your professional income. In plain English:
- If you earn money as an unincorporated realtor, you’ll pay tax on that income at your personal tax rate. That can be over 50% on income over $200k, for a successful realtor. That will not change if you earn it in a corporation, and take all the money out.
- However…. if you earn money but leave it in the company…. You’ll pay personal tax on what you do take out. But any money left in the company will be taxed at the much lower corporate rate – 12.5% on the first $500k.
- If you leave all your earnings in the company, that means you can invest with “87 cent dollars”, not “50 cent dollars”. That allows you to build up wealth faster.
- But do be clear: Most people ultimately want to take the money out at some point. When you do, you will pay the step-up to the personal tax rate. Therefore, this is not an absolute tax saving. It’s a deferral of when you pay the tax (as mentioned by OREA). Of course, that deferral could last 30 years….
In certain cases, the last reason above is enough to incorporate. Be aware that it comes with increased complexity and cost.
I mentioned that it’s not clear whether or not you can hold or trade real estate in a PREC. If not, the world doesn’t end: you set up another company. That company can borrow money from the PREC and use it to invest in whatever it wants. However, some restrictions apply, and of course now you have two companies to deal with…..
Blatant marketing plug: We have developed a full-service package to meet the needs of realtors who want to set up a PREC. Please reach out to us via our contact form or call our office.
This applies to realtors and non-realtors alike.
The only significant advantage of using a corporation to hold real estate is liability protection: the risk that your tenant slips and falls, and sues you personally. In that case, your personal assets are at stake. If the landlord is a corporation, then less at risk. The benefit of this protection will increase over time: presumably, you’ll have more tenants who might sue you…. and presumably, you’ll have more assets at risk. However….. this is why we have insurance companies.
Many people call and ask if there are tax advantages of holding property in a corporation. The short answer is “No”.
Please go back and re-read Part 1 to refresh yourself on the potential tax advantages of a corporation.
Unfortunately….these only apply to an active business. That covers income earned from professional activities as a realtor. Or any other active business, such as accounting.
But, unless you have at least 5 full-time-equivalent employees, a company that holds investments does not qualify. That includes rental properties. You won’t qualify for the cap gain exemption on sale. Worse, any surplus on rental income will be taxed at the personal rate – not that much-nicer 12.5% corporate rate.
Being in Windsor, we also see many cross-border issues: eg. a shareholder who’s a US resident or a US citizen. That makes it even worse. Too complex, call to discuss.
Therefore….. Sorry. As a rule, we typically advise against setting up a corporation to hold investment properties. There are minimal advantages, fairly significant costs, and it gets more complex than it needs to. Hold them in your own name, and get good insurance.
*FOOTNOTE: If you really want to know, I feel that the Real Estate and Business Brokers Act rules this out, via a very broad definition of a “trade” in real estate – see https://www.ontario.ca/laws/statute/02r30#BK1. I would love to be proved wrong. The press release above seems to imply that you can use a PREC for this purpose.