This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore North America. These articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.
Are you in the real estate industry who is interested in reducing your current taxes? Have you considered using the profit from your business for other investment purposes? If so, incorporation may be right for you.
As of October 2020, Ontario real estate agents are allowed to operate their business through personal real estate corporations (“PRECs”). PRECs permit agents to access the advantages of incorporation, including:
- Tax deferral on income
- Possible access to lifetime capital gains exemption on sale of shares
- Income splitting with family members
Tax Deferral and Income Splitting
The main benefit of incorporation is the opportunity for tax deferral. Active business income earned by a PREC is subject to a tax rate of 12.2%on the first $500,000 of active business income earned in Ontario. For income earned above $500,000, the corporate tax rate is 26.5%. These rates compare favourably to the top personal tax rate of 53.5% when income exceeds $220,000. An agent does not need to pay personal tax until funds are withdrawn from the corporation. Tax deferral is achieved by retaining income in the corporation. For those real estate agents that require all of their income for living expenses, the corporation would not allow for this deferral benefit.
A PREC can pay income to the agent and his or her family members as salary or dividend. Tax savings are achieved when there is income splitting among family members at a lower tax rate. In recent years, the government had imposed limitations on income splitting, thus income allocated to family members may have adverse tax consequences. Generally, the family member receiving salary or dividend must be actively involved in the business of the PREC. In addition, dividends can be paid from the PREC to the spouse or common law partner of the agent when the agent is 65 years of age or older. The age of the spouse is not relevant.
Access to Capital Gains Exemption
When shares of certain corporations are sold, the shareholders can claim the Enhanced Capital Gains Exemption (LCGE). As of 2020, this exemption is $883,384. It is indexed each year. In order to be eligible there are tests for assets held over the last 24 months before the sale and as of the day of the sale. For a real estate broker, this tax benefit would be available if the broker sold its PREC. In order to be eligible, it is important for the PREC to avoid the accumulation of non business assets. If the PREC is being used for the deferral of personal taxes, there would be an accumulation of non business assets. Based on the nature of the real estate broker business, it is likely that the benefit of the LCGE will be less relevant than the benefit of personal tax deferral.
Criteria of PRECs
A PREC must be incorporated or continued under the
Business Corporations Act. The PREC can only be controlled by one registrant – the controlling shareholder. The controlling shareholder must be a registrant with the Real Estate Council of Ontario under the
Trust and Real Estate Services Act. He or she must own all of the voting, equity shares of the PREC, and cannot delegate the key roles or the control of the PREC to others. The controlling shareholder must be the sole director and the president of the PREC. Non-voting/ non-equity shares of the PREC can be owned by the controlling shareholder, the family members of the controlling shareholder, or a trust established for a minor child or children of the controlling shareholder. Family members include children, spouse, common-law partner, and parents. However, tax limitations may restrict the income paid from the PREC to the family members unless they are active in the business working full time. Full time is defined as 20 hours per week throughout the year.
Other Benefits of PRECs
PRECs can also be used for investment purposes (owning rental properties, marketable securities, and insurance policies), and for carrying on other business, whether it is related to earning real estate commissions or not. However, PRECs should not purchase personal properties (such as homes, cottages, and boats) as these could be considered shareholder benefits, which are taxable to the shareholders in the year the benefit was conferred.
Setting up a PREC involves the transfer of the agent’s existing business into a corporation. There will be extra legal and accounting costs related to incorporation and tax filing. Advice should be sought to determine whether a PREC will meet the needs and goals of the agent and his or her family.
Written by Echo Lee, CPA, MTax, MTI, from Segal LLP. This document was written for our quarterly bulletin, Canadian Overview, published by Canadian member-firms of Moore North America.