As of October 1, 2020, Ontario real estate salespeople and brokers are able to incorporate their real estate business through a Personal Real Estate Corporation (PRECs). This will allow realtors to benefit from tax saving and tax deferral.
SHOULD YOU INCORPORATE?
There are advantages and disadvantages of incorporating your real estate business, therefore, your decision should be based on your personal circumstances. Remember to consult your legal and tax experts before establishing PREC.
BENEFITS OF INCORPORATING
The main benefit of incorporation is the difference in tax rates between individual and corporate rates, which allows for a potential tax deferral of greater than 40%. Generally, you should incorporate if your income is higher than the cost of your lifestyle.
Currently, corporate tax rate for active business income in Ontario is 12.2% on the first $500,000. In contrast, the highest personal income tax rate in Ontario is 53.53%.
Note that taxes are not avoided or reduced. Corporation can provide you a mechanism to defer tax.
Let’s consider the following example related to commissions from you real estate activities earned personally compared to corporation. For this, assume that you and your corporation are residents of Ontario and corporation qualifies for the small business tax rate.
Let’s say you earn $300,000 annually from your real estate activities. Your operating expenses are $58,000 and you require $90,000 for your living expenses. In addition, you’d like to contribute $27,230 to your RRSP, therefore, you will need $152,000 of salary or self-employment income.
If you continue working as a self-employed salesperson, your personal tax on the net income of $214,770 would be roughly $78,000, leaving you with $136,770. You will then spend $90,000 on your living expenses, and you will have $46,770 after-tax cash available for reinvesting.
In contrast, if you incorporate and pay yourself a salary of $152,000, your corporate taxable income will be $90,000. You will then pay $10,980 in corporate taxes and will have $79,020 in after-tax cash available for reinvesting. Your personal tax payable in this case will be $34,770.
If you incorporate, you will have $32,250 more cash available for reinvesting in your PERC.
In addition to tax deferral, corporations may offer the opportunity to claim a capital gains exemption and a potential for income splitting with family members.
DISADVANTAGES OF INCORPORATING
There are several disadvantages of incorporating your real estate business as opposed to running it as a sole proprietorship, including:
the greater complexity to the Income Tax Act in the taxation of the corporate income; therefore, higher accounting fees for annual compliance work;
certain formal procedures that must be followed by a corporation as required by the legislation;
extra paperwork.
CONCLUSION
There is more paperwork and compliance work involved, but in my opinion, these are relatively insignificant issues compared to the potential tax deferral and wealth creation opportunity that’s available in the corporation with proper short, medium and long-term planning.
Not sure whether it makes sense for you to incorporate? Let’s chat.
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