Navigating Nuances: Personal Real Estate Corporations

Emily Mantle, CPA, CA

If you are a real estate agent in Ontario, you likely have heard that, as of October 1, 2020, you have the ability to incorporate a personal real estate corporation (PREC) to recognize the income you earn from your real estate activities. That is, provided your brokerage is willing to enter into an agreement with your PREC (you should confirm that first, as a brokerage is not obligated to do so).

The opportunity to incorporate has been afforded to many other professionals for years and this recent change in legislation is welcome by many real estate agents. With this new opportunity, you, too, will finally be able to plan and manage what is likely one of your largest expenses: income tax.

By now, you may have a good handle on the fundamental advantages of establishing a PREC. Here are the top two:

Tax deferral

The corporate tax rate on the first $500,000 of active business income is currently 12.2 percent in Ontario. Corporate income not eligible for the small business deduction is taxed at the general corporate tax rate of 26.5 percent. In contrast, the top combined tax rate on personal income in Ontario is 53.53 percent. With a corporation in place, your PREC pays annual corporate tax on net income earned in your PREC. However, you only pay personal tax on the amount of funds you withdraw from your PREC to meet your personal living expenditure needs. Herein lies the opportunity.

Where you are earning more income than you personally need to live on, you can benefit significantly from tax deferral. This tax deferral occurs when you leave funds inside your corporation as your PREC will have only paid 12.2 percent or 26.5 percent corporate tax on its annual income. You won't be taxed personally until you withdraw the funds for your personal use.

In conjunction with your MNP advisor, you can then plan the timing of personal withdrawals from your PREC to manage your personal tax liability. As individuals are taxed on a progressive basis in Canada, this split between corporate and personal taxation allows you to effectively manage your overall tax burden over the course of your life because you are in effect controlling your personal tax exposure on an annual basis.

You don't have this same flexibility with an unincorporated business. You pay tax at the progressive personal tax rates on 100 percent of your income each year from an unincorporated business, regardless of whether you needed all the income earned to live on. Given that real estate can be volatile from year-to-year, a PREC is very advantageous in smoothing personal income between high- and low-income years.

Accumulate wealth quicker

The lower corporate tax rates can allow you to accumulate wealth or to grow your real estate business quicker than you may otherwise have been able to.

Wealth accumulation can occur faster in a corporate context because the income earned inside a PREC is only subject to the first level of taxation (the corporate tax rate being 12.2 percent or 26.5 percent, depending upon circumstances) and the remaining funds can be left inside the PREC and used however you see fit.

For example, every $100 of active business income earned inside a PREC will leave your PREC with either $87.80 (12.2 percent corporate tax) or $73.50 (26.5 percent corporate tax) to reinvest inside the PREC. In contrast, at the top personal tax rate, every one-hundred dollars earned in an unincorporated business would leave you only $46.47 to invest. The other $53.53 would go to the government with no ability to defer the tax payment.

At the top rate, it's easy to imagine how an after-tax fund availability of $73.50 or $87.80 can help you accumulate wealth at a faster pace than $46.47 in an unincorporated context. This same analogy also applies to reinvesting in the growth of your real estate business. For example, the after-corporate-tax funds could be deployed in various areas: perhaps you want to hire an assistant to help you manage the administrative aspect of your business and now you can save funds in the company with the future prospect of doing so.

This can free up more of your time to allow you to focus on growing your client base and developing and maintaining relationships with your referral partners. Similarly, another example is potentially being able to undertake even more marketing initiatives to help you grow, as there would be more funds available for immediate use in the business by virtue of paying less immediately to the government.

DETAILS

Having grasped the fundamental advantages of establishing a PREC, you may now be dealing with some of the nuances of establishing a PREC, including:

Naming of the PREC

Each PREC must be incorporated or continued under the Ontario Business Corporations Act. There are no specific requirements with respect to naming the PREC other than the requirements set out in the Ontario Business Corporations Act which are applicable to all provincially incorporated entities. However, the Real Estate Council of Ontario (RECO) has provided a reminder that the PREC must not represent to the public that the PREC trades in real estate.

As such, while a realtor has flexibility over the name of their corporation, a realtor should be cautious of not selecting a corporation name that may give this trading perception to the public. While a numbered company can be used (e.g., 1234567 Ontario Inc. – the numbers being issued by the Ministry of Government and Consumer Services upon incorporation), many of my clients have recently chosen to adopt the format of Name Personal Real Estate Corporation.

Articles of Incorporation

There are no restrictions in place that limit the ability of the PREC to carry on activities other than their real estate services, with the exception of a realtor receiving compensation for a trade in real estate (certain criteria has to be met for this to occur without PREC registration).

As such, while the Articles of Incorporation can optionally specify restrictions on business activities if the realtor chooses, there is no requirement to outline any restriction within the Articles. In some other professions, there are requirements wherein the Articles of Incorporation are ultimately registered / approved by regulatory bodies prior to a Certificate of Authorization being issued. Fortunately, the PRECs are a bit simpler to set up from this perspective as no registration or certificates are required where certain conditions are met.

With no limitations in place, this also means that the earnings retained inside the PREC can be used to accumulate wealth of the realtor. For example, retained earnings can be used to build a portfolio of investments, real estate properties, and rental properties. However, prior to building an investment portfolio, investing in real estate, or acquiring a rental property, you should always reach out to your MNP advisor who can explain the tax implications of doing so and provide recommendations to you on where to hold such investments. For example, perhaps establishing a holding corporation might be more appropriate in certain circumstances.

Holding Corporation

The legislation requires all the equity shares (e.g., voting common shares) of a PREC must be legally and beneficially owned, directly or indirectly, by the controlling shareholder. The controlling shareholder must be the individual realtor. As such, a holding corporation can be established and can own the equity shares of the PREC provided that the same individual realtor holds all the equity shares of the holding corporation that owns the PREC. This would be an example of indirect ownership.

Family members are also permitted to own non-equity shares directly or indirectly, which also means that family members can own non-equity shares of the holding corporation that owns the PREC. Please speak with your MNP advisor on whether a holding corporation structure would be beneficial in your circumstances.

Real Estate Teams

Many real estate agents operate as part of a team. Each PREC must be controlled by one individual realtor and, as previously discussed, the definition of controlling shareholder within the regulation means the controlling shareholder owns all the equity shares of the PREC. This means that a group of realtors cannot come together to own equity shares of one PREC. Instead, each individual realtor will require their own PREC.

In the case of realtors who are spouses, this can increase the compliance costs associated with having a corporate structure in place from a family perspective as there would be two PRECs instead of one. However, it is unavoidable. From my readings into why there is this limitation, I understand the restriction was designed to permit RECO to identify and discipline an individual registrant where required for each PREC without creating the requirement of each PREC to be registered.

Realtors continuing to operate in a team should review the agreements with each other and the brokerage to ensure that all agreements are updated to reflect the use of individual PRECs amongst the team members that have individual PRECs in place.

Conclusion

The ability for realtors to incorporate a PREC has been a long time coming. Now that it’s finally here, some of you may be hesitant to make the leap. You fundamentally understand the benefits, but a corporation can bring a lot of unknowns and work. This includes the actual process of incorporating, shutting down your unincorporated business accounts with the Canada Revenue Agency, opening new business accounts for the corporation with the Canada Revenue Agency, shutting down an old unincorporated business bank account and opening new corporate bank account, transitioning accounting systems for a different entity, learning how to pay yourself from your corporation, new filing deadlines and additional compliance obligations, etc.

MNP is here to guide you through this entire process on a step-by-step basis. Through our corporate services and online bookkeeping service, ease, we can take care of many of the tasks on your behalf to make the transition from unincorporated to incorporated as seamless as possible. You can then focus on doing what you do best: real estate. In turn, we can take pride in knowing that we are working with you to identify, develop, and meet your goals – both in life and in business. Just like in your business, the relationship matters.

To find out more about PRECs, view MNP’s webinar What Bill 145 Means for Realtors here. Or contact Emily Mantle, CPA, CA at [email protected].