The majority of real estate professionals in Ontario are currently self-employed as sole proprietors working for real estate brokerages. A sole proprietorship is a one-owner business that—unlike a corporation, LLC, or partnership—is not a separate legal entity, and so earnings are subject to personal income tax rates in the year the income is received. Unlike dentists, doctors, accountants and lawyers, real estate professionals in this province have not been allowed to enjoy the benefits of incorporation. Until now.
As of October 1st 2020, individual real estate professionals in Ontario have the option of incorporating their business as a Personal Real Estate Corporation (PREC) under the new Trust in Real Estate Services Act, 2020.
Who is eligible?
Only registered real estate professionals (salespeople or brokers) engaged by a brokerage to trade in real estate can incorporate as a PREC. A PREC cannot carry out business as a brokerage, and the PREC can only trade in real estate for the brokerage that has engaged their services.
PREC ownership
All equity shares of a PREC must be owned directly or indirectly by the individual real estate professional. Any non-equity shares can be owned directly or indirectly by either the real estate professional or by their immediate family members: spouse, child, parent, or a trust established for minor children.
Advantages and disadvantages
There are definite tax advantages associated with incorporation. There are also some disadvantages that will be more applicable to some professionals than others depending on their personal circumstances.
Main advantages of a PREC
A PREC offers significant opportunities for income tax deferral. In Ontario, the first $500,000 of a PREC’s income will be taxed at the lowest corporate rate of 12.2%—with income above $500,000 taxed at the general corporate rate of 26.5%. In contrast, the top personal income tax rate (for income over $220,000) in Ontario is currently 53.53%. The lower corporate tax rate translates to more funds available for growth and investment, as the real estate professional would only need to pay personal income tax on amounts they pay themselves as salary or dividends from the PREC’s profits.
The option of deferral, and the choice of paying out salary or dividends (or a combination of the two), provides flexibility in tax planning, retirement planning, and business succession planning. There are also potential savings on Canada Pension Plan (CPP) contributions and the potential for some income splitting opportunities with family members.
Key disadvantages of a PREC
The key disadvantage of a PREC is the amount of administration involved. This burden should not be underestimated as the record-keeping and filing requirements for corporations are quite stringent.
Setting up a PREC involves filing proper Articles of Incorporation and other legal documents (usually with the help of a legal professional), obtaining corporate business numbers for corporate tax filings, and establishing a separate corporate bank account. A PREC, like any corporation, also requires the ongoing maintenance of separate accounting books and accounts, as well as ongoing HST and payroll reporting, regulatory approvals, and year-end accounting processes including the production of annual financial statements.
There is a real professional fee investment associated with all of this record keeping. The annual accounting fees of a PREC can start at $5,000, and there will be ongoing legal costs for the preparation of annual minutes and other filings required by the Business Incorporations Act.
It should also be noted that although a PREC represents an opportunity to defer personal tax, if the income earned by the PREC and taxed at an Ontario corporate rate of 12.2% is then withdrawn in the form of salary or dividends – there is no personal tax deferral.
Here is an example of real estate professional earning $200,000 (net of expenses) who requires all of their income for personal use:
|
Personal |
Corporation |
Tax deferral |
|
| Total income | $ 200,000 | $ 200,000 | |
| Tax rate | Approx. 37.5% |
12.2% |
|
| Total tax | $ 75,000 | $ 24,400 |
$ 50,600 |
| After-tax cash | $ 125,000 | $ 175,600 |
Before distribution |
| Future payout |
Personal |
Corporation |
Net tax savings |
| Actual dividend amount | $ 175,000 | ||
| Dividend tax rate |
Approx. 23.5% |
||
| Total personal tax | $ 47,750 | ||
| Total after-tax cash | $ 125,000 | $ 127,850 | $ 2,850 |
In this case, the net tax savings does not offset the administrative costs and professional fee investment associated with the PREC.
To incorporate or not to incorporate?
For the majority of real estate professionals in Ontario, it will not make sense to incorporate, as they will require the entirety of their income to meet their lifestyle expenses.
When a real estate professional gets to the point when they are earning more than what they need to meet their expenses, then a PREC might be a good option. But this scenario reflects only a small proportion of the real estate professionals in Ontario. Only the top-earning real estate professionals who can afford to leave money behind in a corporation for a rainy day or investment purposes are the ones who should consider incorporating.
We recommend that any professional considering incorporation should first seek professional advice to discuss their individual circumstances to help determine what makes the most sense for them financially.
S+C Partners is committed to helping you
Our team is here to support you. Please call us at 905-821-9215 or email us at tax@scpllp.com if you have any questions or require any assistance.