What are Personal Real Estate Corporations (PRECs)?
Personal real estate corporations are close to becoming a reality in Ontario after the Government of Ontario’s introduction of new legislation (Trust in Real Estate Services Act (TRESA)) that will modernize the old Real Estate and Business Brokers Act, 2002 (REBBA). Essentially, this means that individual Ontario real estate agents will now be able to incorporate their business if the bill is passed into law, similar to other regulated professionals like doctors, accountants and lawyers. This would allow them to offer more services to clients, invest in new technology and create jobs in their community. More importantly, this opens up avenues for better tax planning for Ontario realtors, which we will discuss below.
What Do Personal Real Estate Corporations Mean for Taxes?
Does it mean Real estate professionals will pay less taxes with Personal Real Estate Corporations in Ontario? Or would they have undue advantage after incorporating? The answer is NO. However, a Corporation definitely opens up some avenues for better tax planning in the long-term. Our Canadian tax system is fundamentally based on the concept of ‘integration’. In simple terms, integration means that everyone should pay the same amount of taxes whether you are incorporated, or you are an individual filer. Does integration work perfectly in the real world? A perfect integration does not exist, and it is difficult to achieve perfect integration.
Canadian legislators have been introducing new legislation over the past few years to close the loopholes that exist in our tax system. Historically, taxpayers and corporations have been benefiting from all the shortcomings that existed in our tax system. This action by the Ontario Government of introducing this legislation is a great step to right direction. If passed, the bill will provide an opportunity to real estate agents to defer taxes into the future, which is something not currently available as a sole proprietor. Tax deferring and claiming current deductions are two key aspects of tax planning. It can result in significant tax savings if it is done right.
Currently, real estate agents report their income as sole proprietorship – which simply means that you as an agent will have to pay taxes on the entire amount you earned minus your applicable deductions in that one year. However, with this change if the legislation is passed, you as an agent will be able to claim all the allowable deductions under your corporation. But, you will have the opportunity to defer your income taxes by not withdrawing all your profit out of the corporation in the same year. Income taxes will be payable at corporation level not individual level. You will only pay personal taxes once you withdraw after tax money from the corporation.
Under the current system, if a real estate agent earns $1 million in commissions, they have no choice but to pay income taxes on the entire amount minus applicable deductions. Under the proposed Personal Real Estate Corporation structure, if an Ontario realtor makes $1 million in commission in any given year, they will first pay corporate taxes at the corporation level, and then personal taxes at their personal tax rate only to the extent that they withdraw funds out of the corporation for personal use. As such, for high income earners who do not need their entire earnings immediately, there is an opportunity to defer personal income, and therefore personal taxes, into the future. This would be especially beneficial to real estate agents whose earnings can fluctuate significantly year over year depending on the timing of their closings.
Should a Real Estate Agent Incorporate? What are the Advantages and Disadvantages?
Incorporating your real estate business has its advantages and disadvantages summarized below:
Advantages of incorporation:
- Lower corporate tax rate of 12.50% plus the agent’s personal taxes (depending on how much is withdrawn from the corporation) versus an average of 30% to 40% personal taxes on entire earnings.
- Tax deferral opportunities – This allows you to grow money on tax deferral basis through various investment vehicles.
- Income splitting between among spouse. Of course, be aware of TOSI rules (Tax on split income)
Disadvantages of incorporation are usually compliance related costs:
- Incorporation charges – This could range from $1,000 to $3,000.
- Higher accounting fees – You might be paying higher fee for corporate filing.
- Stricter compliance – You will be required to submit T4 if you decide to withdraw money through payroll for yourself and spouse. Also, you must make remittance payment on monthly basis to stay in compliance with CRA. Check out our related blog on CRA compliance and deadlines.
- Primarily for high income agents – No advantage if an agent needs all their earnings for personal use – that is, the advantages only exist for high income earning agents who can afford to leave some earnings in the corporation and pay lower tax rate.
Advantages of incorporation outweigh the disadvantages despite the higher compliance and accounting cost. If you are realtor earning $100K you could save up to $10K in taxes on deferral basis assuming you don’t withdraw all earnings out of the corporation in the same year. Tax deferral advantage can be substantial if your earnings are higher. You can also structure your retirement if you’re a savvy investor by investing through your corporation and grow the investment on tax deferral basis. However, you will need to be aware of Small business deduction (SBD) grinding rules.
Please note that by incorporating, your practice will not result in any additional deductions from your income. You can still deduct the expenses that you have been deducting as sole proprietor. The biggest advantage of incorporating is in tax deferral, not in tax deductions.
In summary, this is a progressive step by Ontario Government to bring fairness among all professionals. However, this bill needs to be passed before it can get implemented. This could take years unless the lobby continues to pressure their MPs and relative authority to expedite the process. There might be other complications on nature of the corporation from CRA once the bill is passed. CRA might look at this nature of incorporation as a “business for self” corporation, which limits the deferrals and essentially leaves no room for tax planning.
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