Personal Real Estate Corporations: What You Need to Know
Many real estate agents watched the progress of Bill 145, Trust in Real Estate Services Act, 2020 (TRESA). Early in 2020, this Bill made its way through parliament and received Royal Assent on March 4, 2020. Regulations supporting the Bill were filed on October 1, 2020. TRESA and the supporting regulations created changes for real estate agents in Ontario, including the ability to incorporate a Personal Real Estate Corporation (PREC).
PREC CONDITIONS AND CRITERIA
- A PREC must be incorporated under the Ontario Business Corporations Act.
- The salesperson must hold all of the voting shares of the company and be the only director and officer of the PREC. This makes the salesperson the controlling shareholder.
- Non-voting shares (if any) must be held by the salesperson’s family (spouse, children and/or parents). Shares for a minor child can be held in trust.
- The PREC cannot carry on a business of trading in real estate other than providing the services of its controlling shareholder to the brokerage.
- The PREC and its shareholders cannot represent to the public that the PREC carries on the business of trading in real estate.
- The PREC cannot carry on business as a brokerage or hold any money or property of a client in connection with trading in real estate.
- The PREC cannot receive remuneration from trading in real estate from any person other than the brokerage.
- There must be a written agreement between the PREC, controlling shareholder and brokerage which governs the relationship and ensures the PREC does not hinder the brokerage in its duties under the legislation.
- The salesperson must notify RECO of the legal name and address of the PREC before receiving any remuneration.
- The PREC should register for an HST account with CRA after it’s formed. The salesperson’s current HST account does not transfer.
ADVANTAGES OF INCORPORATING A PREC
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 12.2% for 2020. 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 PREC will likely make sense.
Income splitting (under certain circumstances) – As noted previously, family members can own non-voting shares of the PREC. This would allow the PREC to pay dividends to these family members in an effort to split income and reduce the family’s overall tax burden. However, in 2018 the Tax on Split Income (TOSI) rules came into effect and drastically impacted the ability to income split with family members. A review of the TOSI rules is beyond the scope of this article, but a few points are warranted as they relate to a PREC. If a dividend is subject to TOSI, then instead of being taxed at the family member’s marginal tax bracket, the dividend is taxed at the highest marginal rate for the dividend (47.74% for ineligible dividends in 2020). Most dividends are subject to TOSI unless there is an exclusion. Since the PREC is likely considered a service business, the most useful exclusion to these rules would be for a family member that is 18 or older that is actively engaged (at least 20 hours per week) in the business in the year or any of the previous 5 years. Therefore, a family member that is active it the business (at least 20 hours per week) can receive dividends and not be subject to TOSI. However, it’s prudent to ensure the family member is not performing services for the corporation which would require a real estate license. For family members that are helping the business but not meeting the 20 hours per week threshold, consider paying reasonable wages through the PREC’s payroll account.
Canada Pension Plan (CPP) – If you are a self-employed real estate agent and have business income at or above $58,700 in 2020, you will pay CPP of almost $5,796 (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 PREC 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 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 a PREC 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 establish the PREC and prepare the annual minutes and other filings required by the Ontario Business Corporations 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 12.2% 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 18.2% which can still offer a significant deferral when compared with the highest personal rate in Ontario of 53.53%.
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 PREC, the loss could not be applied to your personal income. Instead, the loss can be applied to income of the PREC 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.
For assistance with setting up and determining if a Personal Real Estate Corporation (PREC) is right for your situation, please connect with a DJB professional.