Historically, real estate agents were prohibited from incorporating their businesses. But changes to the regulations now allow them to obtain a license and form a “personal real estate corporation” (PREC). A PREC gives a real estate agent the same benefits as a Canadian Controlled Private Corporation (CCPC), such as lower tax rates, tax deferrals, and income splitting. But a PREC also limits the scope of business to only real estate broking or ancillary services. It means the corporation cannot develop real estate or do excess trading in stocks and bonds such that trading income overtakes real estate income.
Things to Consider Before Incorporating a Personal Real Estate Corporation (PREC)
Even though real estate brokers can form a PREC, one has to consider various factors before incorporating your business. This article will help you answer five questions that are instrumental in determining if the PREC model benefits your business.
Would Incorporating Bring Significant Tax Benefits Over Sole Proprietor?
A real estate agent has been paying individual income tax between 15- 40% on income earned from the business. A PREC has several tax benefits like small business deduction, lower corporate tax rate, and tax deferral that can reduce tax bill if you are a high-income earner. Incorporation is beneficial if you retain significant earnings in the PREC because withdrawals are subject to income tax.
Note that the Canadian tax system is structured to ensure corporate and personal tax paid by a small business owner on business income is similar to an individual tax. The tax savings depends on how you use the retained earnings. If you use the retained earnings to make more money, PREC can increase your disposable income and make reinvestment less costly. But if you withdraw most business earnings, PREC tax benefits are diluted.
Does Income Splitting Exceptions Apply To You?
In a PREC, the president is the controlling shareholder and owns all equity shares. Family members own non-equity, non-voting shares to get dividends, which are treated as income split and taxed at the highest rate. Hence, incorporation is not beneficial unless you fall under the Tax on Split Income (TOSI) exception.
The TSOI rule has two scenarios that do not consider dividend income as an income split:
- The real estate agent’s age is more than 65
- The spouse works at the business for over 20 hours/per week for a year
If the above scenarios apply, you get tax benefits by incorporating than operating as a sole proprietor.
Do You Want to Avail of the Lifetime Capital Gains Exemption (LCGE)?
If you plan to sell or transfer your business to legal heirs in the long term, incorporating your business can help you avail of the Lifetime Capital Gains Exemption (LCGE). The CRA determines the amount on which any gains from the sale of qualified property are exempt from capital gain tax (CGT). For 2021, the LCGE limit is $892,218. If your capital gain exceeds this limit, you pay CGT on 50% of the realized gain above $892,218 in 2021. Kindly note you recognize the gain after you sell the property.
A PREC will benefit if your business value appreciates as the corporation qualifies for LCGE.
Is the Business Exposed to Legal Liability or Debts?
So far, we have discussed income and tax liability. But a business also has debt and legal liability. You might consider incorporation if you or your company have a huge debt or legal obligation. Incorporation gives your business the status of a legal entity that is separate from you. Your personal debt liability won’t impact the business, and the business debt liability won’t affect your personal bank account. Or the impact would be limited to your share in the organization.
Is the Cost of Running a Personal Real Estate Corporation (PREC) Justified?
As PREC is a separate legal entity, you must create a bank account in the corporation’s name and file taxes separately. You must maintain books, corporate filings, and other paperwork for the PREC. The cost of running a PREC is high with all the legal and accounting work. Hence, incorporation won’t be feasible if the income from the real estate business is not significant. But if your earnings are substantial and you are reinvesting earning in assets that can multiply your business value, these operating costs are justified.
Here we listed some points to consider when evaluating your options to incorporate or not to incorporate. But every case is unique, and a professional accountant can help you determine if a corporation is a right choice for you.
Contact Glenn Graydon Wright LLP in Oakville for Expert Accounting Advice
At Glenn Graydon Wright LLP, our professional accountants will review your business structure and current and long-term needs and guide you on the best possible outcome. If PREC is beneficial in your case, the advisor will provide services to support you through the incorporation process. To learn more about how Glenn Graydon Wright LLP can provide you with the best accounting expertise, call us at 905-845-6633 or connect with us online to set up an initial consultation.