With the Ontario government about to allow a Personal Real Estate Corporation (PREC) for realtors, now is the time to ask: “Should I incorporate my realtor business?” With tax deferrals of up to 41.33% of your profits plus potential tax savings on reinvested profits and through income splitting, realtors are taking a serious look at incorporating. What would those tax savings do for your life?
If you’re eager to find out, please contact your BDO advisor, a member of our BDO Realtor Center of Excellence (contacts below) or me, George Dube, at firstname.lastname@example.org.
Ontario realtors are expected to have incorporation options available to them as of October 1, 2020, based on draft regulations. The regulations open the door to significant tax savings and deferrals. The ability to incorporate realtor activities, a long-standing request, now puts Ontario on equal footing to the majority of provinces.
What are the tax and accounting opportunities available in creating a Personal Real Estate Corporation (PREC)? The Trust in Real Estate Services Act 2020 (TRESA 2020) updates the Real Estate and Business Brokers Act 2002 (REBBA 2002).
What factors determine whether I should incorporate my realtor business?
Many factors affect your decision to incorporate.
It takes little profit to make incorporation worthwhile, contrary to what some people proclaim. In my opinion, a profit of $20,000 that can be kept at the corporate level, or directed to other family members, can justify the costs involved. Do the math instead of just listening to the claims. The quick math is:
When a realtor reaches a profit, or other income, of $100,000, the realtor’s combined federal and provincial tax bracket will be 43.41%, while the PREC’s tax bracket may be 12.2%. The difference of 31.21% multiplied by the $20,000 profit provides the realtor with over $6,000 in tax deferral.
Imagine now the savings on $50,000, $100,000 or more. Imagine with compound interest what this savings program could do for your retirement nest egg and/or retirement timelines. What could it do for your family, or charities?
Some people focus on reaching a specific gross income before incorporating. I suggest focusing on expected profits, family situation, business exit strategy, investment and retirement plans, other family business plans – for now and the future instead.
All this being said, the majority of realtors may not benefit significantly from using a PREC. I do think it is well worthwhile to determine whether you can though. The missed savings and deferrals can be enormous.
What are the potential tax benefits of creating a PREC?
Examples are noted below for your own reference, but, please discuss with your advisor to ensure you understand what the tax savings and deferred taxes are in your specific case.
Going beyond the initial tax deferral, consider these potential tax savings:
- Income splitting with other family members (caution – there are catches!)
- Income splitting in the future of accumulated profits and reinvested earnings
- Specialized remuneration planning with corporations
- Possibility, when properly done, to save considerable taxes in passing assets to the next generation particularly when “estate freezes” and/or family trusts can be included
- Possibility of sale of your PREC to a successor and realizing a portion of the proceeds tax free. For 2020, provided a number of conditions are met, it is possible to sell the shares of a qualifying corporation for just over $880,000 per shareholder without incurring income taxes – although “minimum tax” frequently applies initially (which in many cases can be refunded over seven years).
- Tax effective investing of profits can be done at a corporate level – beyond the fact that you may be investing with say roughly an 88-cent dollar as compared to a 47-cent dollar. Real estate investors relish differences of 1% or 2% on their investments – what an initial difference!
- Flexibility of determining how funds are removed from the company (for example dividends, bonuses, wages or temporary loans), when funds are removed, who receives the funds (subject to certain restricting rules)
- Tax effective way of paying, in certain cases, for memberships (e.g. golf, skiing, social clubs, etc.)
- Ability to save CPP payments (but watch the impact on your future pension payments)
What happens from a tax perspective when I transfer my realtor practice to a corporation?
In short, the Canada Revenue Agency (CRA) deems you to have sold your business to the company for fair market value. There may be a distinct difference of opinion as to the value of the practice between yourself and the CRA. While many businesses will have a minimal value, you can effectively get a degree of protection from a disagreement with the CRA. Your tax and legal teams work together to prepare a tax election and the legal paperwork to defer paying any income tax on such a transfer if there is, or may be, some value.
They will further be working with an experienced business valuation team which BDO Canada has available to help protect you from unexpected taxes. Or, believe it or not, they may want to intentionally trigger taxes if this is best for you. As well, there are GST/HST considerations to address.
When should I set up a realtor corporation (PREC)?
If you should incorporate, sooner is often better, and more financially lucrative, than later. Clearly this is easy to see for realtors with higher income levels who are looking to protect their profits from taxes as soon as possible. For realtors starting off or growing, consider future needs. If you are convinced that today, for example, your business has no value, it is less expensive to complete the incorporation process. Why? Some of the fees related to the tax election on business transfer, business valuation and associated legal paperwork can be avoided.
Further, it can be much easier to get used to using a corporation, handling the bookkeeping, and so on when the business is in the early stages of growth. You can still transfer a larger business, and well worth the effort, but it is easier when smaller. The key is making a decision based on where you believe your business will be in the next few years. Plus, this helps protect you from realizing a few larger commissions personally all of a sudden as your business accelerates. You may not have time to incorporate to protect those commissions with a corporate tax shield.
Can I just create a corporation online?
Sort of…but the potential negative ramifications are significant. Newly created corporations can receive the attention of the CRA to ensure that they were set up correctly. If you’re capable of putting together the correct legal, valuation and tax documents, it’s not a problem. But, the do-it-yourself online incorporation results I see almost always leave out the clauses that protect my clients and open the door to potential tax savings. I expect this is similar from a legal perspective, but please confirm with your legal team.
Further, do you know who the shareholders should be, what types of shares they should own, whether there should be holding or other investment companies and whether a family trust should be part of the structure? Similar to having an experienced realtor buy and sell a home, having an experienced team set things up properly from the beginning is easier than fixing things after the fact.
Are there disadvantages to incorporation?
There are some extra costs in creating a company and then maintaining it. Further, there are extra costs in using the company to its full capability by working with your legal, investment, accounting and tax teams. But, this needs to be compared to the tax and other benefits of using a corporation that your advisors can help with.
Similar to other service related businesses, the CRA may argue that the PREC is a “personal services business” (PSB). This increases the corporate tax rate and reduces available deductions, largely removing the tax advantages of the company. In effect the government is discouraging employees from creating corporations and earning what the CRA would otherwise view as employment income through their corporation. That said, while we acknowledge the risk, for many realtors, if they were considered independent contractors before, this may not be an issue. But you should discuss with your advisor.
What should I be doing differently with my new corporation?
When you have a new company, you have some critical steps to start, and then maintain. For example, considering whether you should register for GST/HST, getting a corporate bank account and setting up an accounting system that lets you effectively manage your business, and withstand the scrutiny of the CRA. We recommend discussing with your advisor to get help in selecting and managing the right system for you.
For more details, see our Checklist for managing a new realtor corporation (PREC).
How can the BDO Realtor Center of Excellence help?
In recognition of the implications of the new regulations and the needs of Ontario’s realtors, BDO has created the BDO Realtor Center of Excellence. This team, consisting of those with proven experience in the industry, helps clients and our fellow partners and colleagues. This means we can apply this expertise to your specific needs, and help you work towards your future goals. Working with our team is an investment. Our clients see returns in tax savings and deferrals, business growth, and peace of mind.
Our Center of Excellence is led by:
- Jameson Bouffard, Leader, National Real Estate Industry (email@example.com)
- George Simpson, Leader, Accounting (firstname.lastname@example.org)
- Peter Cuttini, Leader, Accounting (email@example.com)
- George Dube, Leader, Tax (firstname.lastname@example.org)
Our accounting team focuses on bookkeeping, accounting, budgeting and monitoring client needs. Our tax team focuses on determining setting up your optimal corporate structure, and ongoing tax planning.
What should I do next?
Please do reach out by email to one or all of us. We have regular free webinars planned for realtors and brokerages to discuss incorporation, and answer questions live. We also have on-demand webinars available. For those who want, you can also jump straight into a tax planning meeting with George and his team to get you up and running, saving taxes and deferrals, as quickly as possible.
Special thanks to my partner Adam Thompson, Tax Partner and member of our Real Estate team, for his input.
George E. Dube, CPA, CA, Tax Partner (email@example.com)
Tags: PREC, realtors