Tax-deferral, income-splitting among key benefits.
For higher-bracket real estate professionals, the personal real estate corporation (PREC) is an idea whose time has come. Here’s why.
Doctors, lawyers, dentists, and other regulated professionals have long been able to set up professional corporations. And as of Oct. 1, 2020, real estate professionals in Ontario regulated by the Real Estate Council of Ontario (commonly called Realtors®) may establish a professional corporation called a personal real estate corporation (PREC).
There are a number of key advantages to incorporating your real estate business.
Tax deferral. Efficient tax-planning is the biggest challenge most small businesses face. As a sole proprietorship, real estate agents must report their entire net income in the year it is earned, and then pay tax at their top marginal rate. For higher-bracket agents, this can be a significant tax hit.
Net taxable income of, say, $300,000 in a year attracts the top marginal rate of 53.53% in Ontario. Using a PREC, however, you take out only what you need as personal income and leave the rest in the corporation, where it will attract the corporate tax rate of 12.5% (up to $500,000 and 26.5% above that). Inside the PREC, the funds can be invested and left to grow at a faster rate for retirement. You can then distribute the corporate funds as dividend or income at some future date, perhaps when your marginal tax rate is lower. The overall tax hit is thus cut considerably.
Compensation options. A PREC lets you distribute funds from the corporation as salary, dividends, and bonuses. Consult with your financial planner to determine the timing and method of these payments to maximize tax efficiency.
Family income splitting. Family members who are age 18 or older, and actively involved with, and shareholders of, the real estate business may be paid in dividends, giving you much more flexibility on how and when to distribute income. Because dividends are taxed more favourably than ordinary income, the overall tax hit may be reduced substantially. Family members who may be non-voting, non-equity shareholders of a PREC are a spouse, child, or parent.
Capital gains exemption. When it comes time to sell the business or shares in the business, another advantage of PRECs is that qualified small business corporation shares are sheltered from capital gains tax under a lifetime capital gains exemption of $800,000 indexed for inflation, with 2014 as the base year. For 2020, the exemption amounts to $883,384. Some alternate minimum tax may apply in the year of the sale in some circumstances, but generally the PREC is a great way to shelter capital gains.
Some liability protection. A corporation may provide some protection against creditors (for example, an office and furnishings and equipment). But it won’t provide protection from personal liability – your insurance is designed to do that. Speak to your financial planner about the limits of liability protection when incorporating.
Deducting expenses. Some business expenses that are not fully deductible (e.g., life insurance premiums, meal and entertainment expenses) will be taxed at the lower 12.5% corporate rate than the full marginal personal tax rate applied to a sole proprietorship.
There are, of course, some frictions involved with setting up a PREC.
First of all, a PREC may not be suitable, or even useful, for all real estate agents. The various tax and income-splitting advantages make most sense for those in the highest tax bracket, who don’t need all their income for living expenses, and who can leave a substantial chunk of earnings in the corporation.
Not to be overlooked are the costs and fees associated with incorporation. Incorporating your PERC can cost anywhere between $1,500 and $2,500. If you don’t have an accountant, you’ll need one to keep books for the incorporation and prepare the annual corporate tax return – generally considerably more than for filing a personal tax return.
You’ll also have to be sure to stay onside with all the rules and regulations, not only as a member in good standing of your provincial real estate association, but also as corporate entity. The business must comply with CRA rules regarding reporting monthly payroll (including CPP, EI for employees, and preparing T4s), making dividend payments, and meeting HST and tax instalment deadlines). Breaching any of these can get you into serious difficulties with the CRA, including audits.
If all this sounds daunting, it need not be. The extra effort and paperwork are well worth the trouble for higher-earning real estate agents. But it’s always prudent to consult with your financial planner to make sure you are fully aware of all the responsibilities involved in creating and managing a PREC before you go ahead and sign on the dotted line.