Personal Real Estate Corporations: Advantages Vs. Disadvantages
Many real estate agents are anxiously watching the status of Bill 145, Trust in Real Estate Services Act, 2019. At the time of writing, this Bill had seen its first and second reading in parliament (November 19 and November 25, 2019), been referred to the Standing Committee (November 25, 2019) and has received a motion to arrange proceedings (Dec 11, 2019). If this Bill receives Royal Assent, it will create changes for real estate agents in Ontario, including the ability to incorporate.
Currently, real estate commissions cannot be paid to a person that is not registered under the Real Estate and Business Brokers Act. Therefore, a commission could not be paid to a corporation since it was not registered under this Act. Some realtors worked around this rule by obtaining their brokers license and then registering a sub-brokerage with their current broker. However, if Bill 145 is passed, most real estate agents will be able to set up Personal Real Estate Corporations to receive their commission income.
Advantages of incorporating a real estate business
Tax Deferral – The largest benefit for a successful real estate agent is tax deferral. In Ontario, the Small Business Deduction allows up to $500,000 of active business income (e.g. real estate business income) to be taxed at the lowest corporate rate of 12.5% for 2019. Income in excess of the small business limit, would be taxed at the general corporate rate of 26.5%. In contrast, the highest personal tax rate is 53.53%, which may lead to a large deferral of tax. This means there will be more funds left in the corporation to purchase advertising, hire employees or invest. It should be noted that once the profits are removed from the corporation (such as for personal spending) the benefits of deferral are reduced as the personal withdrawal will be taxed to the individual shareholder as a dividend or salary. Therefore, once a real estate professional gets to a point where they are earning more than what is required to live, the corporation will make sense.
Canada Pension Plan (CPP) – If you are a self-employed real estate agent and have business income at or above $57,400 in 2019, you will pay CPP of almost $5,500 (employer and employee portion). If you transfer your business to a corporation and begin paying yourself dividends you could eliminate this annual cost. However, a decision such as this needs to be part of an overall retirement plan. There may be times you wish to remunerate yourself by way of dividends, and other times by way of a salary. A corporation gives you that flexibility.
Estate and Retirement Planning – You can use the income tax deferral to help plan for retirement. For example, you could use excess funds in the corporation to purchase rental properties, investments, life insurance or an Individual Pension Plan. You may achieve tax savings if you withdraw the amounts from the corporation in retirement at a lower rate. In Ontario, you could draft a second will that deals with just your ownership in your corporation. This allows the shares of the company to pass to your beneficiaries without estate administration taxes (probate fees). These are just a few examples of how corporations provide more flexibility.
Disadvantages of Incorporating
Administration – The main disadvantage of incorporation comes in the form of administration, which translates to additional costs. Since the corporation is a separate entity, it has to file its own income tax return. To do so you will need appropriate accounting records so you can produce annual financial statements, which include an income statement and a balance sheet. You may need to hire both a bookkeeper and accountant to look after these matters. You will also need to incur legal costs to incorporate the business and prepare the annual minutes and other filings required by the Business Incorporations Act.
Passive Income Grind on Small Business Deduction – When a corporation earns passive income (i.e. investment income) in excess of $50,000 in its prior year, certain rules will reduce the small business deduction available to that corporation and, as such, its ability to access the 12.5% corporate tax rate. However, even if this occurs, the general corporate tax rate applies for federal purposes but the small business rate still applies for Ontario purposes. This leads to tax rate of 18.5% which can still offer a significant deferral.
Losses More Difficult to Use – When you operate a real estate business as an individual and incur a loss, you can deduct that loss against your other personal income. If you were operating that same business through a corporation, the loss could not be applied to your personal income. Instead, the loss can be applied to income of the corporation only. The company could carry the loss back up to three years or forward up to twenty years to reduce taxable income on a future return.