This article on real estate partnerships is taken from our quarterly newsletter, Canadian Overview, published by the Canadian member firms of Moore North America. The articles in our newsletter are part of our mission to become the partner of choice for your success by keeping you up to date.
BY ECHO LEE, CPA, MTAX, MTI, DE SEGAL LLP
Do you work in the real estate sector, and are you looking to reduce your current taxes? Have you considered using the profit generated by your business for other investment purposes? If so, incorporation could be the right solution for you.
Since October 2020, real estate agents in Ontario have been authorized to conduct business through real estate partnerships (“RPGs”). SCIs give agents access to the benefits of incorporation, including the following:
– Income tax deferral
– Possible access to lifetime capital gains exemption on sale of shares
– Income splitting between family members
Tax deferral and income splitting
The main advantage of incorporation is tax deferral. Income from the activities of an active business corporation is subject to a tax rate of 12.2% on the first $500,000 of such income earned in Ontario. For income in excess of the first $500,000, the corporate tax rate is 26.5%. These rates are more advantageous than the highest personal tax rate of 53.5% applied to income in excess of the first $220,000. An agent does not have to pay tax as an individual until the funds are drawn from the corporation. Tax is deferred by withholding income from the company. For real estate agents who need all their income to pay their living expenses, the company would not allow this deferral benefit.
An SCI can pay income to the agent and his family members in the form of salary or dividends. Tax savings are achieved when income is split among family members at a lower tax rate. In recent years, the government has imposed restrictions on income splitting, so income allocated to family members can have negative tax consequences.
Generally speaking, the family member receiving the salary or dividends must be actively involved in the SCI’s activities. In addition, dividends may be paid by the SCI to the agent’s spouse or common-law partner, if the agent is age 65 or over. The age of the spouse is irrelevant.
Access to capital gains exemption
When shares of certain companies are sold, shareholders can claim an enriched capital gains exemption. As of 2020, this exemption is $883,384. It is indexed annually. To qualify for this exemption, assets held during the 24 months preceding the sale and from the day of sale are subject to testing. A real estate agent could benefit from this tax advantage if he has sold his SCI. To qualify, it is important for the SCI to avoid accumulating assets that do not belong to the company. Indeed, if the SCI is used to defer personal income taxes, there will be an accumulation of assets that do not belong to the company.
Depending on the nature of the real estate agent’s business, the benefit of an enriched capital gains exemption will be less than the benefit of an individual tax deferral.
SCI criteria
An SCI must be incorporated or continue to operate under the Business Corporations Act. The SCI must be controlled by a single shareholder – the dominant shareholder. The controlling shareholder must be registered with the Real Estate Council of Ontario under the Real Estate Services Trust Act. He must own all the voting and participating shares in the SCI, and may not delegate key roles or control of the SCI. The controlling shareholder must be the sole director and president of the SCI. Non-voting or non-participating shares in the SCI may be held by the controlling shareholder, members of his family or by a trust set up for one or more of his minor children.
Family members include children, spouse, common-law partner and parents. However, tax restrictions may limit the income paid by the SCI to family members, unless they are actively involved in the company’s activities on a full-time basis. Full-time” means working 20 hours a week all year round.
Other SCI advantages
SCIs can also be used for investment purposes (ownership of rental property, marketable securities and insurance policies), and to conduct other activities, whether or not related to brokerage commission earnings. However, non-trading property companies should not acquire personal assets (such as homes, second homes and boats), as these assets could be considered as benefits conferred on shareholders in the year in which the benefit is conferred.
Setting up an SCI involves transferring the agent’s existing business into a joint-stock company. Additional legal and accounting costs will apply for incorporation and tax filing. The agent should seek advice to determine whether an SCI will meet his or her needs and objectives, and those of his or her family.
