Effective October 1, 2020, real estate salespersons and brokers in Ontario are now allowed to carry on their business through a corporation. These corporations are referred to as Personal Real Estate Corporations (“PREC”). Incorporation allows these real estate professionals access to many tax benefits they did not previously enjoy as self-employed individuals. Some of the main tax advantages include:
DEFERRAL OF TAX
The most immediate benefit of incorporation comes in the form of tax deferral. In Ontario, the corporate income tax rate is only 12.2% compared to self-employed individuals who are subject to income tax rates as high as 53.5%. The low corporate tax rate allows more after-tax cash to be left in the company and invested. Leaving the money in the PREC and paying it out to the shareholder over time – especially in a low-income year – can result in additional tax savings. It is important to note that these tax deferral benefits are only achieved if the income is left in the PREC. If all or most of the income earned by a PREC is required for living expenses and therefore withdrawn annually by the shareholder, there will be negligible, or no tax deferral benefits.
INCOME SPLITTING OPPORTUNITIES
Shareholders of a PREC may include the real estate professional’s spouse, children and parents. This may allow for income splitting with lower income family members. We caution that, under current rules, income splitting is only allowed for family members who are active in the business. However, income splitting with a spouse in the future when the real estate professional turns 65 years of age is allowed and this provides an excellent opportunity to use the PREC as a tax-deferred savings vehicle for retirement.
Though the income splitting opportunities with inactive family members are currently minimal, it is always possible the government may change or relax the rules in the future. It is beneficial to issue shares to multiple family members when a PREC is formed because it is far more complicated to bring in new shareholders after the PREC has been in business.
LIFETIME CAPITAL GAINS EXEMPTION
Individuals are allowed a significant tax break if they sell shares of a private company that carries on an active business, such as a real estate professional’s business. The capital gains exemption ($883,384 in 2020) allows shareholders to shelter gains upon sale of the PREC shares. Therefore, incorporating a business could enable the real estate professional to shelter the growth in the value of the company tax free, up to the lifetime capital gains exemption.
EMPLOYEE VERSUS SELF-EMPLOYED
The tax benefits of incorporation are not available to individuals who are considered employees of a brokerage. CRA has issued guidelines specific to real estate professionals as a useful reference for individuals who are uncertain whether they are working as employees of a brokerage or as a self-employed individuals. CRA’s guidelines can be found here: https://www.canada.ca/en/revenue-agency/services/tax/canada-pension-plan-cpp-employment-insurance-ei-rulings/cpp-ei-explained/real-estate-agents.html#determine
COST OF A PREC
Although incorporation can provide many tax benefits, there are administrative requirements and costs to consider. It is important to remember that a PREC is a separate legal entity. In addition to the initial legal costs of setting up the corporation, there are annual filing, bookkeeping and accounting expenses to consider.
The PREC must maintain annual corporate minutes, adequate record keeping for the CRA and potential payroll remittance requirements. HST compliance is also important. In many cases, setting up the PREC will require transferring the existing business into the PREC and proper elections need to be filed to ensure the transfer of the business is done on a tax-deferred basis.
Many self-employed individuals may have been preparing their own tax returns in the past. Tax compliance for a corporation will normally require the services of a professional accountant.
The PREC must ensure it meets the requirements of the Trust in Real Estate Services Act at all times. This Act prescribes the conditions the corporation must meet in order to receive remuneration from a brokerage.
A PREC may be a great tool to reduce the tax burden. However, there is no one size fits all approach, and each individual situation is unique. If you wish to further discuss the option of a PREC, we would be glad to guide you through the process.