If you have been a real estate agent for a number of years, you understand that the more commission that you earn, the more tax you pay. The other side of this coin is that you pay less tax in years when your commissions are lower. Over the years this would balance out if the income rate was the same for all levels of income, but it is not. The rates listed below demonstrate this:
Canada has the following federal progressive tax rates for 2020:
- 15% on the first $48,535 of taxable income
- 20.5% on the portion of taxable income over $48,535 up to $97,069
- 26% on the portion of taxable income over $97,069 up to $150,473
- 29% on the portion of taxable income over $150,473 up to $214,368
- 33% on the portion of taxable income over $214,368
For Ontario the progressive tax rates are as follows:
- 5.05% on the first $44,740 of taxable income
- 9.15% on the next $44,741 to $89,482 of taxable income
- 11.16% on the next $89,483 to $149,999
- 12.16% on the next $150,000 to $219, 999
- 13.16% on $220,000 and higher
Ontario Now Allowing Personal Real Estate Corporations
As of October 1st, a new Ontario regulation permitting the creation of Personal Real Estate Corporations (PRECs) has come into force. The Trust in Real Estate Sevices Act (TRESA) came into force recently, replacing the Real Estate and Business Brokers Act (2002) (“REBBA”). For the first time in Ontario’s history, TRESA enables real estate professionals to incorporate a PREC and enjoy the associated benefits. Ontario now joins a number of other provinces where PRECs have been allowed for several years, including British Columbia, Nova Scotia and Manitoba.
Prior to the new PREC legislation, each real estate agent would pay tax on his/her total income for the year. The new legislation allows real estate professionals to incorporate their business, allowing for better management of their income taxes.
Translating this into the actual numbers, the tax deferral works as follows. In Ontario, the corporate tax rate is 12.2% for the first $500,000 of active business income (real estate commission) for 2020. Income in excess of the small business limit (corporate income tax term) would be taxed at the general corporate tax rate of 26.5%. In contrast, the lowest personal tax rate for 2020 is 20.05%, and the highest personal tax rate for 2020 is 53.53%. If you are generating more income than you need to cover your personal living costs, there can be significant tax savings realized through incorporating a PREC.
Background information on Personal Real Estate Corporations
A PREC is a corporation that provides professional services and is regulated by a governing professional body such as the Real Estate Council of Ontario. The legislation has been amended to permit a brokerage to pay remuneration owed to a salesperson or broker for trading in real estate to a corporation that meets specific criteria.
A PREC is exempt from registration under REBBA and is permitted to receive remuneration from a brokerage if the PREC meets all the required criteria and satisfies all the conditions set out in the legislation. A PREC cannot trade in real estate other than to provide the services of its controlling shareholder (the broker or salesperson) to a brokerage. The salesperson or broker must continue to be employed by the brokerage in order to trade in real estate and to have their remuneration paid to their PREC.
A personal real estate business before this new legislation operated as a sole proprietorship. Proprietorships and partnerships operate under the conditions of unlimited liability. If they are sued by someone, that claim can be applied to both business and personal assets. A professional corporation, on the other hand, allows for limited liability. If you incorporate your real estate business and you get sued, you will only lose the amount you invested (exceptions apply, but generally you’ll only lose the investment). If you’re not incorporated, you could potentially lose all of your personal assets.
If you’re a professional corporation and are sued for malpractice, however, it will be a claim against your Errors and Omissions (E&O) insurance. The corporation cannot protect you.
However, if you default on a loan, your personal assets are protected by the corporation.
Advantages of Incorporation:
- Lower corporate tax rate 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 a tax deferral basis through various investment vehicles.
- Allows for income splitting between spouses. Of course, there are rules to be aware of regarding taxes on split income.
Disadvantages of Incorporation:
Disadvantages of incorporation are usually compliance-related costs:
- Incorporation charges, generally ranging from $1,000 to $2,500.
- Higher accounting fees for filing a corporate return as opposed to a personal one.
- Stricter compliance regulations. You will be required to submit T4 if you decide to withdraw money through payroll for yourself and your spouse. Also, you must make remittance payments on a monthly basis to stay in compliance with CRA.
- The benefits primarily apply to high-income agents who can afford to leave a portion of their earnings in the corporation. There is little advantage for an agent who needs all their earnings for personal use.
If you are a real estate agent or broker and interested in learning more about the possible benefits of setting up your real estate business as a PREC, please contact the experienced Chartered Professional Accountants at Edelkoort Smethurst Schein CPAs LLP by calling 905-517-2297 or reaching out online.