The tax advantages of a personal real estate company – Taxation

There has been a lot of discussion recently about the possibility for real estate agents to incorporate now, including a recent article written by my colleagues. As part of the discourse, it is important to explore some of the tax benefits derived from Personal Real Estate Corporations (“PRECs”). In this first part of a series of several articles, I explore the possibility of deferring taxes by having a PREC keep some or all of the income earned by the real estate agent.

In Ontario, the top marginal personal income tax rate is 53.53% in 2020. A PREC, however, may only have to pay up to 26.5% tax on that income in a first time, while an additional tax is only due when the individual withdraws this money from the PREC for his personal use. The different tax rates in the first instance (53.53% to 26.5%) make it possible to defer the tax as long as the funds are kept in the PREC.

So, for example, if a real estate agent earned $400,000 per year, he would pay taxes in total of about $180,000 (~45%) on that income. Each dollar of additional income would incur 53.53 cents in tax. If, alternatively, he/she earned this income in a PREC, taxes of up to only about $105,000 would be owed in the first place. (Assuming the Realtor has no other sources of income, personal taxes in the amount of approximately $78,000 would be owed if the ~$295,000 were subsequently withdrawn from the PREC as a dividend.) Rather than paying the Canada Revenue Agency immediately, the $75,000 in deferred taxes ($105,000 vs. $180,000) could be reinvested by the PREC.

The analysis does not stop there. Many people rely on their income to meet their daily expenses. If the real estate agent needs $220,000 to live on personally (i.e. the after-tax income he was previously earning), using a PREC would actually be detrimental to the agent. The total tax paid by the agent and the PREC in a year would exceed what he would otherwise have paid had he earned the income personally. (The Canadian corporate tax system is based on perfect integration, but integration is never perfect and right now there is over-integration, which means more overall corporate and personal tax is paid if all income earned by a corporation in a year is distributed to its shareholder(s) in the same year.In the example above, a total of corporate taxes and individuals about $183,000 would be owed instead of $180,000 had nothing been done.)

But what if the agent only needs part of his income to cover his daily expenses? If, for example, he only needed $100,000 in after-tax income, he would only need to receive a dividend of $110,000 out of the $295,000 after-tax PREC, which would allow it to keep a significant part of its income in the PREC and benefit from this reduced corporate tax rate.

In conclusion, if a real estate agent does not need all or part of their annual income to finance their personal expenses, the use of a PREC can have a significant impact on personal finances. The other articles in this series will discuss the additional tax benefits associated with using a PREC.

Originally published by Minden Gross, December 2020

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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